Assessing the Risk, Return and Efficiency of Banks’ Loans Portfolios

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Assessing the risk, return and efficiency of banks’ loans portfolios ∗
Javier Menc´ ıa Bank of Spain June 2008 Preliminary and Incomplete

Abstract This paper develops a dynamic model to assess the risk and profitability of loans portfolios. I obtain their risk premia and derive the risk-neutral measure for an exponentially affine stochastic discount factor. I employ mean-variance analysis with a VaR constraint to assess efficiency. Then I compare Spanish institutions in an empirical application, where small institutions seem to be less efficient than large ones on aggregate terms, while commercial and savings banks perform better on their respective traditional markets. Finally, I find increasing discrepancies between riskneutral and actual default probabilities since June 2007 and discuss their possible sources. Keywords: Credit risk, Probability of default, Asset Pricing, Mean-Variance allocation, Stochastic Discount Factor, Value at Risk. JEL: G21, G12, G11, C32, D81, G28.

This paper is the sole responsibility of its author. The views represented here do not necessarily reflect those of the Bank of Spain. Thanks are due to Alfredo Mart´ for his valuable suggestions as well as for ın, help with the interest rate database. Of course, the usual caveat applies. Address for correspondence: Alcal´ 48, E-28014 Madrid, Spain, tel: +34 91 338 5414, fax: +34 91 338 6102. a



1

Introduction
Standard capital market theory states that there is a risk-return tradeoff in equilib-

rium. The more risk one is willing to take, the higher the return one will be able to get. This relationship has been extensively analysed in the context of liquid assets that trade in organised markets (see e.g. Fama and MacBeth, 1973; Ghysels, Santa-Clara, and Valkanov, 2005). However, much less is known about its implications on the behaviour of banks as risk managers and profit maximisers.…...

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