Success and Failure of the Financial Regulation on a Surplus-Driven Financial Company

This paper studies an optimal asset allocation problem for a surplus-driven financial institution facing a quantile-based constraint (a Value-at-Risk or an Average Value-at-Risk constraint), or a shortfall-based constraint (an expected shortfall or an expected discounted shortfall constraint). We obtain closed-form solutions to the optimal wealth for the non-concave utility maximization problem under constraints. We find that the quantile- and shortfall-based regulation can effectively reduce the probability of default for a surplus-driven financial institution. However, the liability holders' benefits typically cannot be fully protected under either type of regulation.

Keywords: Value-at-Risk; Expected Shortfall; Average Value-at-Risk; Non-concave optimization; Equivalence

JEL Classification: C61; D81; G11

Suggested Citation: Suggested Citation

Chen, An and Stadje, Mitja and Zhang, Fangyuan, Success and Failure of the Financial Regulation on a Surplus-Driven Financial Company (September 9, 2021). Available at SSRN: https://ssrn.com/abstract=3920338 or http://dx.doi.org/10.2139/ssrn.3920338