Regulation Risk

Forthcoming in North American Actuarial Journal

24 Pages Posted: 20 Apr 2020

See all articles by Olivier Le Courtois

Olivier Le Courtois

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control

Jacques Lévy Véhel

Regularity Team Inria Saclay

Christian Pierre Walter

Foundation Maison des Sciences de l'Homme (FMSH) - Collège d'études mondiales

Date Written: September 16, 2019

Abstract

Market risk regulations adopted in response to recent crises aim to reduce financial risks. Nevertheless, a large number of practitioners feel that, if these rules seem to succeed in lowering volatility, they appear to rigidify the financial structure of the economic system and tend to increase the probability of large jumps: prudential rules seem to produce an unexpected effect, the swap between volatility risk and jump risk. The aimed reduction of volatility is accompanied by an increase in the intensity of jumps. The new regulations seem create a new risk. This paper discusses this idea in three ways. First, we introduce a conventionalist framework to put some light on this unexpected effect. Second, we precisely define volatility risk and the intensity of jumps to document the risk swap effect by analysing a daily time series of the SP500 index. Third, we propose a model which allows one to appreciate a practical consequence of this swap on the risk measures. We conclude by challenging the main objective of regulation: we argue that concentrating on reducing the sole volatility can create a new type of risk which increases the potential losses, that we term regulation risk.

Suggested Citation

Le Courtois, Olivier Arnaud and Lévy Véhel, Jacques and Walter, Christian Pierre, Regulation Risk (September 16, 2019). Forthcoming in North American Actuarial Journal. Available at SSRN: https://ssrn.com/abstract=3561902

Olivier Arnaud Le Courtois (Contact Author)

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control ( email )

23, av. Guy de Collongue
69134 Ecully Cedex
France

Jacques Lévy Véhel

Regularity Team Inria Saclay ( email )

Paris
France

Christian Pierre Walter

Foundation Maison des Sciences de l'Homme (FMSH) - Collège d'études mondiales ( email )

Bâtiment Le France
190-196 avenue de France
Paris, 75013
France

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