The stability of efficiency rankings when risk-preferences and objectives are different

No 2006,08, Discussion Paper Series 2: Banking and Financial Studies from Deutsche Bundesbank, Research Centre

Abstract: We analyze the stability of efficiency rankings of German universal banks between 1993 and 2004. First, we estimate traditional efficiency scores with stochastic cost and alternative profit frontier analysis. Then, we explicitly allow for different risk preferences and measure efficiency with a structural model based on utility maximization. Using the almost ideal demand system, we estimate input and profit demand functions to obtain proxies for expected return and risk. Efficiency is then measured in this risk-return space. Mean risk-return efficiency is somewhat higher than cost and considerably higher than profit efficiency. More importantly, rankorder correlation between these measures are low or even negative. This suggests that best-practice institutes should not be identified on the basis of traditional efficiency measures alone. Apparently, low cost and/or profit efficiency may merely result from alternative yet efficiently chosen risk-return trade-offs.

Keywords: Risk; efficiency; banks; Germany (search for similar items in EconPapers)
JEL-codes: D21 G21 G33 L21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban and nep-eff
Date: Written 2006
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