A VaR-Constrained Mean-Variance Model: Implications for Portfolio Selection and the Basle Capital Accord.

Abstract:     
We examine the economic implications arising from using a VaR-constrained mean-variance model for portfolio selection and for the calculation of a bank's minimum regulatory capital. Surprisingly, we show that it is plausible that when a VaR constraint is imposed, certain risk-averse agents end up selecting portfolios with larger standard deviations than they would have chosen in the absence of a VaR constraint. Therefore, regulators such as the Basle Committee for Banking Supervision should be aware that allowing a bank to use VaR to determine its minimum regulatory capital may lead to an increase in the standard deviation of the bank's portfolio.

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