Banking Firm and Two-Moment Decision Making

The economic environment for financial institutions has become increasingly risky. Hence these institutions must find ways to manage risk of which one of the most important forms is interest rate risk. In this paper we use the mean-variance (mean-standard deviation) approach to examine a banking firm investing in risky assets and hedging opportunities. The mean-standard deviation framework can be used because our hedging model satisfies a scale and location condition. The focus of this study is on how interest rate risk affects optimal bank investment in the loan and deposit market when derivatives are available. Furthermore we explore the relationship among the first- and second-degree stochastic dominance efficient sets and the mean-variance efficient set