Risk Management, Capital Budgeting and Capital Structure Policy for Financial Institutions: An Integrated Approach

Kenneth Froot and Jeremy Stein

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: We develop a framework for analyzing the capital allocation and capital structure decisions facing financial institutions such as banks. Our model incorporates two key features: I) value-maximizing banks have a well-founded concern with risk management; and ii) not all the risks they face can be frictionlessly hedged in the capital market. This approach allows us to show how bank-level risk management considerations should factor into the pricing of those risks that cannot be easily hedged. We examine several applications, including: the evaluation of proprietary trading operations; and the pricing of unhedgeable derivatives portfolios.

This paper was presented at the Financial Institutions Center's May 1996 conference on "

Date: 1996-05
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Related works:
Journal Article: Risk management, capital budgeting, and capital structure policy for financial institutions: an integrated approach (1998)
Working Paper: Risk Management, Capital Budgeting and Capital Structure Policy for Financial Institutions: An Integrated Approach (1996)
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