Optimization Letters

, 2:555 | Cite as

Optimal allocation between bank loans and treasuries with regret

  • M. P. Mulaudzi
  • M. A. Petersen
  • I. M. Schoeman
Original Paper


The main categories of assets held by banks are loans, Treasuries (bonds issued by the national Treasury), reserves and intangible assets. In our contribution, we investigate the investment of bank funds in loans and Treasuries with the aim of generating an optimal final fund level. Our results take behavioral aspects such as risk and regret into account. More specifically, we apply a branch of optimization theory that enables us to consider a regret attribute alongside a risk component as an integral part of the utility function. In this case, regret-aversion corresponds to the convexity of the regret function and the bank’s preference is assumed to be representable by optimization subject to the utility. In addition, we provide a comparison between risk- and regret-averse banks in terms of optimal asset allocation between loans and Treasuries. A feature of our contribution is that these and other optimization issues are analyzed briefly and, where possible, represented graphically. Furthermore, we comment on the claim that an investment away from loans towards Treasuries is responsible for credit crunches in the banking industry.


Optimization theory Financial economics Banks Credit crunch 


  1. 1.
    Basel Committee on Banking Supervision. International Convergence of Capital Measurement and Capital Standards; A Revised Framework. Bank for International Settlements (June 2004). http://www.bis.org/publ/bcbs107.pdf
  2. 2.
    Bell D.E.: Regret in decision making under uncertainty. Oper. Res. 30, 961–981 (1982)MATHCrossRefGoogle Scholar
  3. 3.
    Fischer K.P.: Pricing pension fund guarantees: a discrete martingale approach. Can. J. Adm. Sci. 16, 256–266 (1999)Google Scholar
  4. 4.
    Gollier, C., Salanie, B.: Individual decisions under risk, risk-sharing and asset prices with regret. Working Paper (2005)Google Scholar
  5. 5.
    Loomes G., Sugden R.: Regret theory: an alternative theory of rational choice under uncertainty. Econ. J. 92, 805–824 (1982)CrossRefGoogle Scholar
  6. 6.
    Mulaudzi, M,P., Petersen, M.A., Schoeman, I.M.: Risk and regret in the banking sector. In: Electronic Proceedings of the 4th IASTED International Conference on Financial Engineering and Applications (FEA2007). UC Berkeley, Berkeley California USA, 24-27 September 2007, Paper no. 588-013Google Scholar
  7. 7.
    Quiggin J.: Regret theory with general choice sets. J. Risk Uncertain. 8, 153–165 (1994)MATHCrossRefGoogle Scholar
  8. 8.
    Sugden R.: An axiomatic foundation of regret. J Econ. Theor. 60, 159–180 (1993)MATHCrossRefMathSciNetGoogle Scholar

Copyright information

© Springer-Verlag 2008

Authors and Affiliations

  • M. P. Mulaudzi
    • 1
  • M. A. Petersen
    • 1
  • I. M. Schoeman
    • 1
  1. 1.North-West University (Potchefstroom Campus)PotchefstroomSouth Africa

Personalised recommendations