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

Capital Budgeting in Banks 255
RAROC
High
Correlation
Low
Correlation
Hurdle
Rate
Risk
Figure 6.2 Changes in RAROC for changes in riskiness and correlation.
Note: Results for plotting this graph are derived similarly to Crouhy et al.
(1999).
cause such projects would make them “break even” earlier with the required
and fixed rate of return, indicating that they create value.
Since we are considering an NPV = 0 project here, it is obvious that the
implicit assumption that RAROC compensates correctly for changes in risk 75
is wrong. The bank would have to determine the beta of the transaction 76
in order to find out about the true value of the project. However, this will
be impossible in practice—especially for illiquid credits. Crouhy et al. therefore
suggest the calculation of an adjusted RAROC, 77 which we will not
discuss here. 78
Let us now turn to transactions with either positive or negative NPV,
that is, when I ≠ V A,0
. So far, there has been no need to discuss and deter-
75 See Wilson (1992), p. 112.
76 See Crouhy et al. (1999), p. 20.
77 This adjusted RAROC corrects for the steepness of the RAROC curve for increases
in riskiness, making it a constant function. However, this holds only true for NPV
= 0 projects.
78 Their model is also extremely difficult to parameterize because they suggest an
“instantaneous” equity beta (β E
= (V A,0
/V E,0
) ⋅ N(d 1
) ⋅β A
) to derive the hurdle rate,
with N(d 1
) as in the Black-Scholes OPT and β as in the CAPM.