Banking Firm, Risk of Investment and Derivatives
Udo Broll, Wing-Keung Wong, Mojia Wu
DOI: 10.4236/ti.2011.23023   PDF    HTML     5,324 Downloads   9,738 Views   Citations


The economic environment for financial institutions has become increasingly risky. Hence these institutions must find ways to manage risk of which one of the most important forms is credit risk. In this paper we use the mean-variance (mean-standard deviation) approach to examine a banking firm investing in risky assets and hedging opportunities. The mean-standard deviation framework can be used because our hedging model satisfies a scale and location condition. The focus of this study is on how credit risk affects optimal bank investment in the loan and deposit market when derivatives are available. Furthermore we explore the relationship among the first- and second-degree stochastic dominance efficient sets and the mean-variance efficient set.

Share and Cite:

U. Broll, W. Wong and M. Wu, "Banking Firm, Risk of Investment and Derivatives," Technology and Investment, Vol. 2 No. 3, 2011, pp. 222-227. doi: 10.4236/ti.2011.23023.

Conflicts of Interest

The authors declare no conflicts of interest.


[1] X. Freixas and J.-C. Rochet, “Microeconomics of Banking,” 2nd Edition, MIT Press, Cambridge, 2008,
[2] J. Bessis, “Risk Management in Banking,” 3rd Edition, Wiley & Sons, Chichester, 2009.
[3] Th. C. Wilson, “Portfolio Credit Risk,” Federal Reserve Bank of New York Economic Policy Review, Vol. 4, No. 3, 1998, pp. 71-82.
[4] F. A. DeRoon, T. E. Nijman and B. J. M. Werker, “Currency Hedging for International Stock Portfolios: The Uselfulness of Mean-Variance Analysis,” Journal of Banking & Finance, Vol. 27, No. 2, 2003, pp. 327-350. HUdoi:10.1016/S0378-4266(01)00251-5U
[5] H. Schneewei?, “Entscheidungskriterien bei Risiko,” Springer, Berlin, 1967.
[6] J. Meyer, “Second Degree Stochastic Dominance with Respect to a Function,” International Economic Review, Vol. 18, No. 2, 1977, pp. 476-487. HUdoi:10.2307/2525760U
[7] J. Meyer, “Two-Moment Decision Models and Expected Utility Maximization,” American Economic Review, Vol. 77, No. 3, 1987, pp. 421-430.
[8] A. L?ffler, “Variance Aversion Implies μ-σ2-Criterion,” Journal of Economic Theory, Vol. 69, No. 2, 1996, pp. 532-539.
[9] Z. Bar-Shira and I. Finkelshtain, “Two-Moments Decision Models and Utility-Representable Preferences,” Journal of Economic Behavior & Organization, Vol. 38, No. 2, 1999, pp. 237-244. HUdoi:10.1016/S0167-2681(99)00008-6U
[10] W.-K. Wong and C. K. Li, “A Note on Convex Stochastic Dominance Theory,” Economics Letters, Vol. 62, No. 3, 1999, pp. 293-300. HUdoi:10.1016/S0165-1765(98)00231-6U
[11] M. Ormiston and E. Schlee, “Mean-Variance Preferences and Investor Behavior,” Economic Journal, Vol. 111, No. 474, 2001, pp. 849-861. HUdoi:10.1111/1468-0297.00662U
[12] A. Wagener, “Prudence and Risk Vulnerability in Two-Moment Decisions Models,” Economics Letters, Vol. 74, No. 2, 2002, pp. 229-235. HUdoi:10.1016/S0165-1765(01)00541-9U
[13] U. Broll, J. E. Wahl and K.-W. Wong, “Elasticity of Risk Aversion and International Trade,” Economics Letters, Vol. 92, No. 1, 2006, pp. 126-130. HUdoi:10.1016/j.econlet.2006.01.031U
[14] W.-K. Wong and C. H. Ma, “Preferences over Location-Scale Family,” Economic Theory, Vol. 37, No. 1, 2008, pp. 119-146. HUdoi:10.1007/s00199-007-0254-3U
[15] H. M. Markowitz, “Portfolio Selection, Cowles Foundation Monograph 16,” Wiley, New York, 1959.
[16] J. Von Neumann and O. Morgenstern, “Theory of Games and Economic Behavior,” John Wiley, New York, 1947.
[17] G. Hanoch and H. Levy, “Efficiency Analysis of Choices Involving Risk,” Review of Economic Studies, Vol. 36, No. 3, 1969, pp. 335-346. HUdoi:10.2307/2296431U
[18] D. P. Baron, “Information, Investment Behavior, and Efficient Portfolios,” Journal of Financial and Quantitative Analysis, Vol. 9, No. 4, 1974, pp. 555-566. HUdoi:10.2307/2329760U
[19] H. Levy, “Two-Moment Decision Models and Expected Utility Maximization: Comment,” American Economic Review, Vol. 79, No. 3, 1989, pp. 597-600.
[20] H.-W. Sinn, “Expected Utility, μ-σ Preferences, and Linear Distribution Classes: A Further Result,” Journal of Risk and Uncertainty, Vol. 3, No. 3, 1990, pp. 277-281. HUdoi:10.1007/BF00116785U
[21] A. W. Roberts and D. E. Varberg, “Convex Functions,” Academic Press, New York, 1973.
[22] G. A. Whitmore, “Third-Degree Stochastic Dominance,” American Economic Review, Vol. 60, No. 3, 1970, pp. 457-459.
[23] J. Hadarand and W. R. Russel, “Stochastic Dominance and Diversi?cation,” Journal of Economic Theory, Vol. 3, No, 3, 1971, pp. 288-305. HUdoi:10.1016/0022-0531(71)90024-XU
[24] L. Tesfatsion, “Stochastic Dominance and Maximization of Expected Utility,” Review of Economic Studies, Vol. 43, No. 2, 1976, pp. 301-315. HUdoi:10.2307/2297326U
[25] D. Stoyan, “Comparison Methods for Queues and Other Stochastic Models,” John Wiley, New York, 1983.
[26] G. Davis, “Income and Substitution Effects for Mean-Preserving Spreads,” International Economic Review, Vol. 30, No. 1, 1989, pp. 131-136. HUdoi:10.2307/2526553U
[27] M. S. Kimball, “Standard Risk Aversion,” Econometrica, Vol. 61, No. 3, 1993, pp. 589-611. HUdoi:10.2307/2951719U
[28] H.-W. Sinn, “Economic Decisions under Uncertainty,” North Holland, Amsterdam, 1983.

Copyright © 2024 by authors and Scientific Research Publishing Inc.

Creative Commons License

This work and the related PDF file are licensed under a Creative Commons Attribution 4.0 International License.