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ON MODELING BANKING RISK

  

 

E. G. Tsionas

 

 

Abstract

The paper develops new indices of financial stability based on an explicit model of expected utility maximization by financial institutions subject to the classical technology restrictions of neoclassical production theory. The model can be estimated using standard econometric techniques, like GMM for dynamic panel data and latent factor analysis for the estimation of covariance matrices. An explicit functional form for the utility function is not needed and we show how measures of risk aversion and prudence (downside risk aversion) can be derived and estimated from the model. The model is estimated using data for Eurozone countries and we focus particularly on (i) the use of the modeling approach as an “early warning mechanism”, (ii) the bank- and country-specific estimates of risk aversion and prudence (downside risk aversion), and (iii) the derivation of a generalized measure of risk that relies on loan-price uncertainty.

 

 

Keywords: Financial Stability; Banking; Expected Utility Maximization; Sub-prime crisis; Financial Crisis; Eurozone; PIIGS.

JEL Classifications: G20, G21, C51, C54, D21, D22.

 

 

Acknowledgments: This paper has benefited from the generous financial support and hospitality of the Bank of Greece. The author wishes to thank Heather Gibson for many useful comments on an earlier version. The views expressed in this paper are those of the author and do not necessarily reflect those of the Bank of Greece. Any errors are my own.

 

 

Correspondence:

E. G. Tsionas

Athens University of Economics and Business

76 Patission Str.,10434 Athens,Greece.

email: tsionas@otenet.gr

 


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