Value-at-Risk Based Risk Management: Optimal Policies and Asset Prices
October 1999
Alexander Shapiro, Suleyman Basak
ABSTRACT
This paper analyzes optimal, dynamic portfolio and wealth/consumption policies of utility maximizing investors
who must also manage market-risk exposure using a given risk-management model. We focus on the industry standard,
the Value-at-Risk (VaR) based risk management, and find that VaR risk managers often optimally choose a larger
exposure to risky assets than non risk managers, and consequently incur larger losses, when losses occur. We suggest
an alternative risk management model, based on the expectation of a loss, to remedy the shortcomings of VaR. A
general-equilibrium analysis reveals that the presence of VaR risk managers in a pure-exchange economy amplifies
the stock-market volatility at times of down markets (and low output) and attenuates the volatility at times of
up markets.
Subject: Investments/Portfolio Choice; Investments/Volatility of Asset Prices; Risk Management
Classification: Theoretical
Shapiro: (212) 998-0362 ashapiro@stern.nyu.edu
Basak: (215) 898-6087 basaks@wharton.upenn.edu
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