Risk Horizon and Rebalancing Horizon in Portfolio Risk Measurement

36 Pages Posted: 30 Apr 2009 Last revised: 17 Jul 2011

Multiple version iconThere are 2 versions of this paper

Date Written: April 29, 2009

Abstract

This paper analyzes portfolio risk and volatility in the presence of constraints on portfolio rebalancing frequency. This investigation is motivated by the incremental risk charge (IRC) introduced by the Basel Committee on Banking Supervision. In contrast to the standard market risk measure based on a ten-day value-at-risk calculated at 99% confidence, the IRC considers more extreme losses and is measured over a one-year horizon. More importantly, whereas ten-day VaR is ordinarily calculated with a portfolio's holdings held fixed, the IRC assumes a portfolio is managed dynamically to a target level of risk, with constraints on rebalancing frequency. The IRC uses discrete rebalancing intervals (e.g., monthly or quarterly) as a rough measure of potential illiquidity in underlying assets. We analyze the effect of these rebalancing intervals on the portfolio's profit and loss distribution over a risk-measurement horizon. We derive limiting results, as the rebalancing frequency increases, for the difference between discretely and continuously rebalanced portfolios; we use these to approximate the loss distribution for the discretely rebalanced portfolio relative to the continuously rebalanced portfolio. Our analysis leads to explicit measures of the impact of discrete rebalancing under a simple model of asset dynamics.

Keywords: risk management, portfolio risk, liquidity

JEL Classification: G11

Suggested Citation

Glasserman, Paul, Risk Horizon and Rebalancing Horizon in Portfolio Risk Measurement (April 29, 2009). Available at SSRN: https://ssrn.com/abstract=1396850 or http://dx.doi.org/10.2139/ssrn.1396850

Paul Glasserman (Contact Author)

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