Broll, Udo and Wong, Wing-Keung and Wu, Mojia
(2013):
*Banking Firm and Two-Moment Decision Making.*

Preview |
PDF
MPRA_paper_51687.pdf Download (112kB) | Preview |

## Abstract

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 interest rate 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 interest rate 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.

Item Type: | MPRA Paper |
---|---|

Original Title: | Banking Firm and Two-Moment Decision Making |

Language: | English |

Keywords: | banking firm, investment, technology, risk, derivatives, hedging,(mu,sigma)-preferences, stochastic dominance. |

Subjects: | G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages G - Financial Economics > G2 - Financial Institutions and Services > G22 - Insurance ; Insurance Companies ; Actuarial Studies |

Item ID: | 51687 |

Depositing User: | Wing-Keung Wong |

Date Deposited: | 25 Nov 2013 16:17 |

Last Modified: | 02 Oct 2019 22:29 |

References: | Bai, Z.D., Hui, Y.C., Wong, W.K., Zitikis, R., 2012. Evaluating Prospect Performance: Making a Case for a Non-Asymptotic UMPU Test. Journal of Financial Econometrics 10(4), 703-732. Bai, Z.D., Li, H., Liu, H.X., Wong, W.K., 2011. Test Statistics for Prospect and Markowitz Stochastic Dominances with Applications. Econometrics Journal 122, 1-26. Bai, Z.D., H.X. Liu and W.K. Wong 2009. Enhancement of the Applicability of Markowitz's Portfolio Optimization by Utilizing Random Matrix Theory. Mathematical Finance 19(4), 639-667. Bai, Z.D., H.X. Liu and W.K. Wong 2011. Asymptotic Properties of Eigenmatrices of A Large Sample Covariance Matrix, Annals of Applied Probability 21(5), 1994-2015. Bai, Z.D., K.Y. Wang and W.K. Wong 2011. Mean-Variance Ratio Test, A Complement to Coefficient of Variation Test and Sharpe Ratio Test, Statistics and Probability Letters 81(8), 1078-1085. Bar-Shira Z. and Finkelshtain, I., 1999, Two-moments decision models and utility-representable preferences, Journal of Economic Behavior & Organization 38, 237-244. Baron, D.P., 1974, Information, investment behavior, and efficient portfolios, Journal of Financial and Quantitative Analysis 9(4), 555-66. Bawa, V.S., 1975, Optimma rules for ordering uncertain prospects, Journal of Financial Economics 2, 95-121. Bessis, J., 2009, Risk management in banking, 3/e, Chichester, Wiley & Sons. Broll, U., M. Egozcue, W.K. Wong, and R. Zitikis, 2010, Prospect Theory, Indifference Curves, and Hedging Risks, Applied Mathematics Research Express 2010(2), 142-153. Broll, U., Wahl, J.E. and Wong, K-W., 2006, Elasticity of risk aversion and international trade, Economics Letters 92, 126-130. Chan, C.Y., C. de Peretti, Z. Qiao, and W.K. Wong, 2012, Empirical Test of the Efficiency of UK Covered Warrants Market: Stochastic Dominance and Likelihood Ratio Test Approach, Journal of Empirical Finance 19(1), 162-174. Davis, G., 1989, Income and substitution effects for mean-preserving spreads, International Economic Review 30, 131-136. DeRoon, F.A., Nijman, T.E. and Werker, B.J.M, 2003, Currency hedging for international stock portfolios: The uselfulness of mean-variance analysis, Journal of Banking & Finance 27, 327-350. Egozcue, M., L. Fuentes Garcíac, W.K. Wong, and R. Zitikis, 2011, Do Investors Like to Diversify? A Study of Markowitz Preferences, European Journal of Operational Research 215(1), 188-193. Egozcue, M., and W.K. Wong 2010, Gains from Diversification: A Majorization and Stochastic Dominance Approach, European Journal of Operational Research 200, 893-900. Fong, W.M., H.H. Lean, and W.K. Wong, 2008, Stochastic Dominance and Behavior towards Risk: The Market for Internet Stocks, Journal of Economic Behavior and Organization 68(1), 194-208. Fong, W.M., W.K. Wong, and H.H. Lean, 2005, International Momentum Strategies: A Stochastic Dominance Approach, Journal of Financial Markets 8, 89-109. Freixas, X. and Rochet, J.-C., 2008, Microeconomics of banking, 2/e, Cambridge, MA, London, England, MIT Press. Gasbarro, D., W.K. Wong, and J.K. Zumwalt, 2007, Stochastic dominance analysis of iShares, European Journal of Finance 13, 89-101. Hanoch, G. and Levy, H., 1969, Efficiency analysis of choices involving risk, Review of Economic Studies 36, 335-46. Hadar J. and Russel W.R., 1971, Stochastic dominance and diversification, Journal of Economic Theory 3, 288-305. Kimball, M.S., 1993, Standard risk aversion, Econometrica 61, 589-611. Lam, K. T. Liu and W.K. Wong, 2010, A pseudo-Bayesian model in financial decision making with implications to market volatility, under- and overreaction, European Journal of Operational Research 203(1), 166-175. Lam, K. T. Liu and W.K. Wong, 2012, A New Pseudo Bayesian Model with Implications to Financial Anomalies and Investors' Behaviors, Journal of Behavioral Finance 13(2), 93-107. Lean, H.H., McAleer, M., Wong, W.K., 2010, Market Efficiency of Oil Spot and Futures: A Mean-Variance and Stochastic Dominance Approach, Energy Economics 32, 979-986. Levy, H., 1989, Two-moment decision models and expected utility maximization: comment, American Economic Review 79, 597-600. Leung, P.L., Wong, W.K., 2008, On Testing the Equality of the Multiple Sharpe Ratios, with Application on the Evaluation of IShares, Journal of Risk 10(3), 1-16. Li, C.K., and W.K. Wong, 1999. Extension of Stochastic Dominance Theory to Random Variables, RAIRO - Operations Research, 33, 509-524. Loffler, A., 1996, Variance Aversion Implies[mu]-[sigma]2-Criterion, Journal of Economic Theory 69, 532-539. Ma, C. and W.K. Wong, 2010. Stochastic Dominance and Risk Measure: A Decision-Theoretic Foundation for VaR and C-VaR, European Journal of Operational Research 207, 927-935. Markowitz, H,M., 1959, Portfolio Selection, Cowles Foundation Monograph 16, New York, Wiley. Meyer, J. 1977, Second degree stochastic dominance with respect to a function, International Economic Review 18,476-487. Meyer, J., 1987, Two-moment decision models and expected utility maximization, American Economic Review 77, 421-430. Ormiston, M., Schlee, E., 2001, Mean-variance preferences and investor behavior, Economic Journal 111, 849-861. Roberts, A.W., Varberg, D.E., 1973, Convex functions, New York, Academic Press. Schneeweiß, H., 1967, Entscheidungskriterien bei Risiko, Berlin et al., Springer. Sinn, H.-W., 1983, Economic decisions under uncertainty, Amsterdam et al., North Holland. Sinn, H.-W., 1990, Expected utility mu-sigma preferences, and linear distribution classes: a further result, Journal of risk and uncertainty 3, 277-281. Sriboonchitta, S., Wong, W.K., Dhompongsa, D., Nguyen, H.T. 2009. Stochastic Dominance and Applications to Finance, Risk and Economics. Chapman and Hall/CRC, Boca Raton, Florida. Stoyan, D., 1983, Comparison Methods for Queues and Other Stochastic Models, John Wiley, New York. Tesfatsion, L., 1976, Stochastic dominance and maximization of expected utility, Review of Economic Studies 43, 301-315. Von Neumann, J. and Morgenstern, O., 1947, Theory of games and economic behavior, John Wiley, New York. Wagener, A., 2002, Prudence and risk vulnerability in two-moment decisions models, Economics Letters 74, 229-235. Wilson, Th.C., 1998, Portfolio credit risk, Federal Reserve Bank of New York Economic Policy Review 4, 71-82. Whitmore G.A., 1970, Third-degree stochastic dominance, American Economic Review 60, 457-459. Wong, W.K., 2006, Stochastic Dominance Theory for Location-Scale Family, Journal of Applied Mathematics and Decision Sciences, 1-10. Wong, W.K. 2007, Stochastic Dominance and Mean-Variance Measures of Profit and Loss for Business Planning and Investment, European Journal of Operational Research 182, 829-843. Wong, W.K., and R. Chan, 2008, Markowitz and Prospect Stochastic Dominances, Annals of Finance 4(1), 105-129. Wong, W.K., Li, C.K., 1999, A note on convex stochastic dominance theory, Economics Letters 62, 293-300. Wong, W.K., and C. Ma, 2008, Preferences over Meyer's location-scale family, Economic Theory 37(1), 119-146. |

URI: | https://mpra.ub.uni-muenchen.de/id/eprint/51687 |