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Risk†Adjusted Measures of Value Creation in Financial Institutions

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  • Alistair Milne
  • Mario Onorato

Abstract

  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.

Suggested Citation

  • Alistair Milne & Mario Onorato, 2012. "Risk†Adjusted Measures of Value Creation in Financial Institutions," European Financial Management, European Financial Management Association, vol. 18(4), pages 578-601, September.
    • Handle: RePEc:bla:eufman:v:18:y:2012:i:4:p:578-601
    DOI: 10.1111/j.1468-036X.2010.00540.x
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    References listed on IDEAS

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    Cited by:

    1. Schmidhammer, Christoph & Hille, Vanessa & Wiedemann, Arnd, 2020. "Performance of maturity transformation strategies," Discussion Papers 58/2020, Deutsche Bundesbank.

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