Journal of Applied Mathematics

An Optimal Portfolio and Capital Management Strategy for Basel III Compliant Commercial Banks

Grant E. Muller and Peter J. Witbooi

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Abstract

We model a Basel III compliant commercial bank that operates in a financial market consisting of a treasury security, a marketable security, and a loan and we regard the interest rate in the market as being stochastic. We find the investment strategy that maximizes an expected utility of the bank’s asset portfolio at a future date. This entails obtaining formulas for the optimal amounts of bank capital invested in different assets. Based on the optimal investment strategy, we derive a model for the Capital Adequacy Ratio (CAR), which the Basel Committee on Banking Supervision (BCBS) introduced as a measure against banks’ susceptibility to failure. Furthermore, we consider the optimal investment strategy subject to a constant CAR at the minimum prescribed level. We derive a formula for the bank’s asset portfolio at constant (minimum) CAR value and present numerical simulations on different scenarios. Under the optimal investment strategy, the CAR is above the minimum prescribed level. The value of the asset portfolio is improved if the CAR is at its (constant) minimum value.

Article information

Source
J. Appl. Math., Volume 2014 (2014), Article ID 723873, 11 pages.

Dates
First available in Project Euclid: 2 March 2015

Permanent link to this document
https://projecteuclid.org/euclid.jam/1425305534

Digital Object Identifier
doi:10.1155/2014/723873

Zentralblatt MATH identifier
07010724

Citation

Muller, Grant E.; Witbooi, Peter J. An Optimal Portfolio and Capital Management Strategy for Basel III Compliant Commercial Banks. J. Appl. Math. 2014 (2014), Article ID 723873, 11 pages. doi:10.1155/2014/723873. https://projecteuclid.org/euclid.jam/1425305534


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