Capital Allocation and Risk Performance Measurement in a Financial Institution

Posted: 15 Mar 2001

See all articles by Stuart M. Turnbull

Stuart M. Turnbull

University of Houston - C.T. Bauer College of Business

Abstract

This paper provides an analytical and practical framework, consistent with maximizing the wealth of existing shareholders, to address the following questions:

What are the costs associated with economic capital?

What is the tradeoff between the probability of default and the costs of economic capital?

How do we take into account the time profile of economic capital when assessing the performance of a business?

What is the appropriate measure of profitability, keeping the probability of default constant?

It is shown that the capital budgeting decision depends not only on the covariance of the return of a project with the market portfolio, but also on the covariance with the bank's existing assets. This dependency arises from the simple fact that the economic capital is not additive.

Suggested Citation

Turnbull, Stuart M., Capital Allocation and Risk Performance Measurement in a Financial Institution. Available at SSRN: https://ssrn.com/abstract=247440

Stuart M. Turnbull (Contact Author)

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

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