Equilibrium Impact of Value-at-Risk Regulation
University of Zurich - Department of Banking and Finance; Swiss Finance Institute; University of Zurich - Faculty of Economics, Business Administration and Information Technology
Zurich Cantonal Bank; University of Basel
Swiss Finance Institute; University of Lugano
September 16, 2003
EFA 2002 Berlin Meetings Discussion Paper
We study the partial and general equilibrium implications of value-at-risk (VaR) regulation in continuous-time economies with intermediate expenditure, stochastic opportunity set, and heterogeneous attitudes to risk. Our findings show that because of an anticipatory effect of VaR constraints on the optimal hedging demand, the partial equilibrium incentives of VaR regulation can lead banks to increase their risk exposure in high-volatility states. In general equilibrium, VaR constraints can produce unambiguously lower interest rates and higher equity Sharpe ratios. The VaR impact on equity volatility and equity expected returns is ambiguous.
Number of Pages in PDF File: 64
Keywords: Value-at-Risk, Stochastic Opportunity Set, Regulatory Policy, Dynamic Financial Equilibria, Perturbation Theory
JEL Classification: G11, G12, G28, D92, C60, C61working papers series
Date posted: November 14, 2002
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