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The Hidden Risks of Optimizing Bond Portfolios under VaR


  • Winker, Peter
  • Maringer, Dietmar


Value at risk (VaR) has become a standard measure of portfolio risk over the last decade. It even became one of the corner stones in the Basel II accord about banks' equity requirements. Nevertheless, the practical application of the VaR concept suffers from two problems: how to estimate VaR and how to optimize a portfolio for a given level of VaR? For the first problem, several approaches have been suggested including the historical simulation method. The optimization problem can be tackled using recent advances in heuristic optimization algorithms. However, our application to bond portfolios shows that a solution to the two aforementioned problems gives rise to a third one: the actual VaR of bond portfolios optimized under a VaR constraint might exceed its nominal level to a large extent. Thus, optimizing bond portfolios under a VaR constraint might increase risk. This finding is of relevance not only for investors, but even more so for bank regulation authorities.

Suggested Citation

  • Winker, Peter & Maringer, Dietmar, 2004. "The Hidden Risks of Optimizing Bond Portfolios under VaR," Research Notes 13, Deutsche Bank Research.
  • Handle: RePEc:zbw:dbrrns:13

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    References listed on IDEAS

    1. Enrico De Giorgi, "undated". "A Note on Portfolio Selection under Various Risk Measures," IEW - Working Papers 122, Institute for Empirical Research in Economics - University of Zurich.
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    Cited by:

    1. Marianna Lyra, 2010. "Heuristic Strategies in Finance – An Overview," Working Papers 045, COMISEF.
    2. Cheridito, Patrick & Stadje, Mitja, 2009. "Time-inconsistency of VaR and time-consistent alternatives," Finance Research Letters, Elsevier, vol. 6(1), pages 40-46, March.
    3. Peter Winker & Marianna Lyra & Chris Sharpe, 2011. "Least median of squares estimation by optimization heuristics with an application to the CAPM and a multi-factor model," Computational Management Science, Springer, vol. 8(1), pages 103-123, April.
    4. Ausin, M. Concepcion & Lopes, Hedibert F., 2010. "Time-varying joint distribution through copulas," Computational Statistics & Data Analysis, Elsevier, vol. 54(11), pages 2383-2399, November.

    More about this item


    VaR; risk; portfolio optimization; heuristic optimization;

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C16 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Econometric and Statistical Methods; Specific Distributions
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General


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