An Analysis of VaR-based Capital Requirements∗
نویسندگان
چکیده
We study the dynamic investment and reporting problem of a financial institution subject to capital requirements based on self-reported VaR estimates, as in the Basel Committee’s Internal Models Approach (IMA). With constant price coefficients, we show that optimal portfolios display a local three-fund separation property. VaR-based capital requirements induce financial institutions to tilt their portfolios towards assets with high expected return (and high systematic risk), but result nevertheless in a decrease of the overall risk of trading portfolios. Overall, we find that capital requirements determined on the basis of the IMA can be very effective not only in curbing portfolio risk but also in inducing truthful revelation of this risk. Journal of Economic Literature Classification Numbers: D91, D92, G11, C61.
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