Value-at-Risk Capital Requirement Regulation, Risk Taking and Asset Allocation: A Mean-Variance Analysis
European Journal of Finance, Volume 21, Issue 3, (2015), 215-241.
47 Pages Posted: 7 Jan 2008 Last revised: 11 Jun 2015
Date Written: January 1, 2015
Abstract
In this study, the Mean-Variance framework is employed to analyze the impact of the Basel VaR market risk regulation on the institution’s optimal investment policy, the stockholders’ welfare, as well as the tendency of the institution to change the risk profile of the held portfolio. It is shown that with the VaR regulation, the institution faces a new Regulated Capital Market Line, which induces resource allocation distortion in the economy. Surprisingly, only when a riskless asset is available does VaR regulation induce the institution to reduce risk. Otherwise, the regulation may induce higher risk, accompanied by asset allocation distortion. On the positive side, the regulation implies an upper bound on the risk the institution takes and it never induces the firm to select an inefficient portfolio. Moreover, when the riskless asset is available, tightening the regulation always increases the amount of maintained eligible capital and decreases risk.
Keywords: Risk Management, Capital Requirement Regulation, Value-at-Risk, Basel Regulations, Regulated Capital Market Line
JEL Classification: G11, G18, G28, G38, E58
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
By Michael J. Brennan and Feifei Li
-
Equilibrium Prices in the Presence of Delegated Portfolio Management
By Domenico Cuoco and Ron Kaniel
-
Portfolio Performance and Agency
By Philip H. Dybvig, Heber Farnsworth, ...
-
Portfolio Performance and Agency
By Philip H. Dybvig, Heber Farnsworth, ...
-
Portfolio Performance and Agency
By Heber Farnsworth, Philip H. Dybvig, ...
-
Portfolio Performance and Agency
By Philip H. Dybvig, Heber Farnsworth, ...
-
Equilibrium Prices in the Presence of Delegated Portfolio Management
By Domenico Cuoco and Ron Kaniel
-
Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management
By Suleyman Basak, Anna Pavlova, ...
-
Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management
By Suleyman Basak, Anna Pavlova, ...