Asset Price Dynamics with Value-at-Risk Constrained Traders

25 Pages Posted: 12 Mar 2002

See all articles by Jon Danielsson

Jon Danielsson

London School of Economics - Systemic Risk Centre

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group

Hyun Song Shin

Bank for International Settlements (BIS)

Date Written: June 2001

Abstract

Risk management systems in current use treat the statistical relations governing asset returns as being exogenous, and attempt to estimate risk only by reference to historical data. These systems fail to take into account the feedback effect in which trading decisions impinge on prices. We investigate the consequences for asset price dynamics of the widespread adoption of such techniques. We illustrate through simulations of a general equilibrium model that, as compared to the case when such techniques are not used, prices are lower, have time paths with deeper and longer troughs, as well as a greater degree of estimated volatility. The magnitudes can sometimes be considerable. Far from promoting stability, widespread adoption of such techniques may have the perverse effect of exacerbating financial instability.

Keywords: value-at-risk, general equilibrium, financial regulation

JEL Classification: G1, G18, G28

Suggested Citation

Danielsson, Jon and Zigrand, Jean-Pierre and Shin, Hyun Song, Asset Price Dynamics with Value-at-Risk Constrained Traders (June 2001). London School of Economics Financial Markets Group Discussion Paper No. 394; EFA 2002 Berlin Meetings Presented Paper. Available at SSRN: https://ssrn.com/abstract=302307 or http://dx.doi.org/10.2139/ssrn.302307

Jon Danielsson

London School of Economics - Systemic Risk Centre ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44.207.955.6056 (Phone)

HOME PAGE: http://www.riskreasearch.org

Jean-Pierre Zigrand (Contact Author)

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6201 (Phone)
+44 20 7955 7420 (Fax)

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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