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Asset Price Dynamics with Value-at-Risk Constrained Traders

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  • Jean-Pierre Zigrand

    ()

  • Jon Danielsson

    ()

  • Hyun Song Shin

    ()

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 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.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp394.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp394.

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Date of creation: Oct 2001
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Handle: RePEc:fmg:fmgdps:dp394

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Web page: http://www.lse.ac.uk/fmg/

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Cited by:
  1. Marvin J. Barth & Philip D. Wooldridge & Eli M Remolona, 2002. "Changes in market functioning and central bank policy: an overview of the issues," BIS Working Papers 120, Bank for International Settlements.
  2. Miguel Segoviano, 2006. "Conditional Probabilty of Default Methodolgy," FMG Discussion Papers dp558, Financial Markets Group.
  3. Miguel A. Segoviano, 2006. "Conditional probability of default methodology," LSE Research Online Documents on Economics 24512, London School of Economics and Political Science, LSE Library.
  4. Marvin Barth & Eli Remolona & Philip Wooldridge, 2002. "Changes in market functioning and central bank policy: an overview of the issues," BIS Papers chapters, in: Bank for International Settlements (ed.), Market functioning and central bank policy, volume 12, pages 1-24 Bank for International Settlements.
  5. Marco Sorge, 2004. "Stress-testing financial systems: an overview of current methodologies," BIS Working Papers 165, Bank for International Settlements.
  6. Leippold, Markus & Trojani, Fabio & Vanini, Paolo, 2006. "Equilibrium impact of value-at-risk regulation," Journal of Economic Dynamics and Control, Elsevier, vol. 30(8), pages 1277-1313, August.
  7. Sorge, Marco & Virolainen, Kimmo, 2006. "A comparative analysis of macro stress-testing methodologies with application to Finland," Journal of Financial Stability, Elsevier, vol. 2(2), pages 113-151, June.
  8. Laurent Clerc & Fran├žoise Drumetz & Fran├žois Haas, 2002. "The influence of structural changes on market functioning and its implications for monetary policy: a focus on the euro area," BIS Papers chapters, in: Bank for International Settlements (ed.), Market functioning and central bank policy, volume 12, pages 43-64 Bank for International Settlements.

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