NBER

Kenneth A. Froot, Jeremy C. Stein

Bibliographic Information

NBER Working Paper No. 5403
Issued in January 1996
NBER Program(s):AP, CF

Published: Journal of Financial Economics (1998). citation courtesy of

Available Formats

Abstract

We develop a framework for analyzing the capital allocation and capital structure decisions facing financial institutions such as banks. Our model incorporates two key features: i) value-maximizing banks have a well-founded concern with risk management; and ii) not all the risks they face can be frictionlessly hedged in the capital market. This approach allows us to show how bank-level risk management considerations should factor into the pricing of those risks that cannot be easily hedged. We examine several applications, including the evaluation of proprietary trading operations, and the pricing of unhedgeable derivatives positions.

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