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The impact of risk regulation on price dynamics

  • Danielsson, Jon
  • Shin, Hyun Song
  • Zigrand, Jean-Pierre

Most financial risk regulations assume that asset returns are exogenous, where risk is estimated from historical data. This assumption fails to take into account the feedback effect of trading decisions on prices. We investigate the consequences of risk constrained trading by means of simulations of a general equilibrium model with a value-at-risk constraint and compare the results to the case when risk constraints are not present. Prices are lower on average in the presence of risk regulation, while volatility is higher. Risk regulation may have the perverse effect of exacerbating price fluctuations.

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

Volume (Year): 28 (2004)
Issue (Month): 5 (May)
Pages: 1069-1087

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Handle: RePEc:eee:jbfina:v:28:y:2004:i:5:p:1069-1087
Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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  1. Suleyman Basak & Alex Shapiro, . "Value-at-Risk Based Risk Management: Optimal Policies and Asset Prices," Rodney L. White Center for Financial Research Working Papers 06-99, Wharton School Rodney L. White Center for Financial Research.
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  7. M.J.B. Hall, 1996. "The amendment to the capital accord to incorporate market risk," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 49(197), pages 271-277.
  8. Blum, Jurg, 1999. "Do capital adequacy requirements reduce risks in banking?," Journal of Banking & Finance, Elsevier, vol. 23(5), pages 755-771, May.
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