Publication: Optimal portfolios with minimum capital requirements
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2012
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Elsevier
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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 riskadjusted
performance of the proposed approach is superior to that of minimum-VaR and minimumstressed VaR portfolios.
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Keywords
Convex optimization, Multivariate GARCH, Out-of-sample evaluation, Stress testing
Bibliographic citation
Journal of Banking and Finance, 2012, v. 36, n. 7, pp. 1928-1942