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Risk‐Adjusted Measures of Value Creation in Financial Institutions
Author(s) -
Milne Alistair,
Onorato Mario
Publication year - 2012
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/j.1468-036x.2010.00540.x
Subject(s) - skewness , economics , risk adjusted return on capital , capital asset pricing model , consumption based capital asset pricing model , portfolio , financial economics , equity (law) , value at risk , skew , debt to equity ratio , financial institution , debt , diversification (marketing strategy) , rate of return , actuarial science , business , finance , risk management , econometrics , financial capital , microeconomics , population , law , sociology , profit (economics) , political science , nonprobability sampling , physics , demography , astronomy , capital formation , marketing
Many financial institutions assess portfolio decisions using RAROC, the ratio of expected return to risk (or ‘economic’) capital. We use asset pricing theory to determine the appropriate hurdle rate, finding that this varies with the skewness of asset returns. We quantify this discrepancy under a range of assumptions showing that the RAROC hurdle rate differs substantially, being higher by a factor of five or more for equity which has a right skew compared to debt which has a pronounced left skew, and also between different qualities of debt exposure. We discuss implications for both financial institution risk management and supervision.