Applying risk appetite to efficiency estimations: The case of Taiwan banks

Abstract

This study applies Data Envelopment Analysis (DEA) to estimate banks' efficiency. In stage 1, we construct a risk appetite index (RAI) by measuring the rank correlation between the order of current excess returns and the order of past riskiness across assets and use the risk appetite index to estimate how much risk banks can bear. In stage 2, we apply the Slacks- Based Measurement (SBM) super-efficiency model to calculate the bank's efficiency. The result shows that many of Taiwan's banks have a low appetite for risk and that the efficiency estimation will be improved when risk appetite is considered in the model.

Keywords:

• Risk appetite
• Efficiency estimation