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

See all articles by Guy Kaplanski

Guy Kaplanski

Bar-Ilan University - Graduate School of Business Administration

Haim Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration; Fordham University

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

Kaplanski, Guy and Levy, Haim, Value-at-Risk Capital Requirement Regulation, Risk Taking and Asset Allocation: A Mean-Variance Analysis (January 1, 2015). European Journal of Finance, Volume 21, Issue 3, (2015), 215-241. , Available at SSRN: https://ssrn.com/abstract=1081288 or http://dx.doi.org/10.2139/ssrn.1081288

Guy Kaplanski (Contact Author)

Bar-Ilan University - Graduate School of Business Administration ( email )

Ramat Gan
Israel

Haim Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration ( email )

Mount Scopus
Jerusalem, 91905
Israel

HOME PAGE: http://pluto.huji.ac.il/~mshlevy/

Fordham University ( email )

140 West 62nd Street
New York, NY 10023
United States

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