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Optimal portfolios with minimum capital requirements

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  • Santos, André A.P.
  • Nogales, Francisco J.
  • Ruiz, Esther
  • Dijk, Dick Van

Abstract

We propose a novel approach to active risk management based on the recent Basel II regulations to obtain optimal portfolios with minimum capital requirements. In order to avoid regulatory penalties due to an excessive number of Value-at-Risk (VaR) violations, capital requirements are minimized subject to a given number of violations over the previous trading year. Capital requirements are based on the recent Basel II amendments to account for the ‘stressed’ VaR, that is, the downside risk of the portfolio under extreme adverse market conditions. An empirical application for two portfolios involving different types of assets and alternative stress scenarios demonstrates that the proposed approach delivers an improved balance between capital requirement levels and the number of VaR exceedances. Furthermore, the risk-adjusted performance of the proposed approach is superior to that of minimum-VaR and minimum-stressed VaR portfolios.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 36 (2012)
Issue (Month): 7 ()
Pages: 1928-1942

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Handle: RePEc:eee:jbfina:v:36:y:2012:i:7:p:1928-1942

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Web page: http://www.elsevier.com/locate/jbf

Related research

Keywords: Convex optimization; Multivariate GARCH; Out-of-sample evaluation; Stress testing;

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References

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Cited by:
  1. Lützenkirchen, Kristina & Rösch, Daniel & Scheule, Harald, 2013. "Ratings based capital adequacy for securitizations," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5236-5247.
  2. Alexander, Gordon J. & Baptista, Alexandre M. & Yan, Shu, 2014. "Bank regulation and international financial stability: A case against the 2006 Basel framework for controlling tail risk in trading books," Journal of International Money and Finance, Elsevier, vol. 43(C), pages 107-130.
  3. Cui, Xueting & Zhu, Shushang & Sun, Xiaoling & Li, Duan, 2013. "Nonlinear portfolio selection using approximate parametric Value-at-Risk," Journal of Banking & Finance, Elsevier, vol. 37(6), pages 2124-2139.

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