Risk Management and Value Creation in ... - Arabictrader.com

230 RISK MANAGEMENT AND VALUE CREATION IN FINANCIAL INSTITUTIONS
A reasonable estimate for µ is 454 the market value 455 weighted average costs
of capital:
V
⎛ ⎞
µ =
E
⋅ ( + β( − ))+ ⎜ − ⎟ ⋅ ( + )
V r R r V
M
1
E
r s
⎝ V ⎠
(5.57)
A
where r = Risk-free rate
R M
= Return on the market portfolio M
R M
– r = Market risk premium
β = Stock market beta as derived in the market model version
of the CAPM
s = Spread above the risk-free rate commensurate with the
bank’s rating
Combining and rearranging Equations (5.55) and (5.56), we can solve
for DP. By doing so, we improve on the prior estimate DP′ for the default
point, and again we use the information implied in the stock market. This
seems reasonable because banks experience a relatively higher liquidity of
their assets when they approach default. However, only the stock market
implicitly contains information of how big the effects are. 456
Hence:
ln(
DP e V A) + µ −05 . σA−σA⋅
=
2 DTD
(5.58)
This reflects the fact that the true DP also deviates from its first estimate
using book values. We assume here implicitly that the stock market information
and the rating contain additional information.
Therefore:
Economic Capital = V A
– DP (5.59)
We will summarize the suggested approach diagrammatically, both to
clarify the required input parameters and to show the dependencies between
them (see Figure 5.12).
The suggested derivation of economic capital heavily depends on the
fact that the top-down approach is based on a closed system of dependent
variables. We are using this property to solve for one of these variables (DP)
in order to be able to determine economic capital.
A
454 Even though asset growth and equity growth are also reasonable candidates for
µ, they have relatively little to do with the return on assets.
455 As derived previously in the iterative procedure.
456 Additionally, this information also considers the fact that banks are heavily regulated
and that the “too-big-to-fail” doctrine might apply to them.