Abstract
Value-at-Risk (VaR) has become the standard criterion for assessing risk in the financial industry. Given the widespread usage of VaR based risk management, it becomes increasingly important to study the effects on the stock market and the option market of these constraints. We therefore introduce a continuous-time asset pricing model, based on Lucas (1978) and Basak and Shapiro (2001), in order to investigate the impact of the VAR risk managers on general equilibrium prices We find that agents with a VAR constraint affect the equilibrium prices remarkably and tend to reduce market volatility, as intended. However, in some cases VAR risk management can undesirably raise the probability of extreme losses. Finally, we demonstrate that option prices in an economy with VAR risk managers display a volatility smile as deserved in practice.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.