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Rev Fin 2001; 14:371-405
© 2001 the Society for Financial Studies

Article

Value-at-risk-based risk management: optimal policies and asset prices

S Basak1,z and A Shapiro2
1 Institute of Finance and Accounting, London Business School, Regents Park, London NW1 4SA, UK
2 New York University, NY, USA
z Corresponding author
E-mail: sbasak@london.edu

Abstract

This article analyzes optimal, dynamic portfolio and wealth/consumption policies of utility maximizing investors who must also manage market-risk exposure using Value-at-Risk (VaR). We 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 amplifies the stock-market volatility at times of down markets and attenuates the volatility at times of up markets.


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