46 Pages Posted: 17 Apr 2017
Date Written: April 13, 2017
This article studies optimal portfolio selection of expected utility maximizing investors who must also manage their market-risk exposures. The risk is measured by a so-called weighted Value-at-Risk (WVaR) risk measure, which is a generalization of both Value-at-Risk (VaR) and Expected Shortfall (ES). Feasibility, well-posedness, and existence of the optimal solution are examined. We obtain the optimal solution when it exists, and show how risk measures change asset allocation patterns. In particular, we characterize three classes of risk measures: the first class will lead to models that admit no optimal solution; the second can necessitate portfolio insurance endogenously; the third will allow economic agents to engage in “regulatory capital arbitrage”, incurring larger losses when losses occur, which includes VaR and ES, two popular regulatory risk measures.
Keywords: Portfolio Selection, Risk Measure, Weighted Value-at-Risk, Value-at-Risk, Expected Shortfall, Portfolio Insurance, Regulatory Capital Arbitrage
JEL Classification: G11, C61
Suggested Citation: Suggested Citation