Alexandre M. Baptista

Economic implications of using a mean-VaR model for portfolio selection: A comparison with mean-variance analysis

We relate Value at Risk (VaR) to mean-variance analysis and examine the economic implications of using a mean-VaR model for portfolio selection. When comparing two mean-variance efficient portfolios, the higher variance portfolio might have less VaR. Consequently, an efficient portfolio that globally minimizes VaR may not exist. Surprisingly, we show that it is plausible for certain risk-averse agents to end up selecting portfolios with larger standard deviations if they switch from using variance to VaR as a measure of risk. Therefore, regulators should be aware that VaR is not an unqualified improvement over variance as a measure of risk.

Portfolio Performance Evaluation Using Value at Risk

Developed here is a value at risk-based measure of portfolio performance called the reward-to-VaR ratio. It is demonstrated that, under normality, the reward-to-VaR ratio gives the same ranking for portfolio performance as the frequently used Sharpe ratio. Under non-normality, the reward-to-VaR ratio at one confidence level may give a ranking for portfolio performance different from the ranking obtained at a different confidence level. This indicates that the risk-taking incentives of a portfolio manager in a VaR-based risk management system can be substantially different from the incentives in a Sharpe ratio-based system.

Spanning with American options

In this paper, we investigate the existence of multiperiod American options generating dynamically complete markets. We show that if a primitive security separates states at the terminal date, then generically there exist multiperiod American options on that security generating dynamically complete markets. We also provide an example of an economy in which multiperiod American options on a primitive security generate dynamically complete markets, while multiperiod European options do not.

On regulatory responses to the recent crisis

Banks around the world suffered huge trading losses in the recent crisis. In response, the Basel Committee on Banking Supervision (2011a) provides a revised framework to determine the minimum capital requirements for their trading portfolios. Moreover, the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) imposes certain restrictions on the composition of the trading portfolios of U.S. banks through the ‘Volcker Rule.’ Our paper assesses the effectiveness of the Basel framework and the Volcker Rule in preventing banks from taking substantive tail risk in their trading portfolios without capital requirement penalties. We find that the Basel framework is ineffective in preventing banks from doing so, but that the Volcker Rule is beneficial in that it partially mitigates this ineffectiveness. We also suggest two alternatives to the Basel framework and discuss the impact of the Volcker Rule if either one of them is adopted.

On Regulatory Responses to the Recent Crisis: An Assessment of the Basel Market Risk Framework and the Volcker Rule

Banks around the world suffered huge trading losses in the recent crisis. In response, the Basel Committee on Banking Supervision (2011a) provides a revised framework to determine the minimum capital requirements for their trading portfolios. Moreover, the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) imposes certain restrictions on the composition of the trading portfolios of U.S. banks through the ‘Volcker Rule.’ Our paper assesses the effectiveness of the Basel framework and the Volcker Rule in preventing banks from taking substantive tail risk in their trading portfolios without capital requirement penalties. We find that the Basel framework is ineffective in preventing banks from doing so, but that the Volcker Rule is beneficial in that it partially mitigates this ineffectiveness. We also suggest two alternatives to the Basel framework and discuss the impact of the Volcker Rule if either one of them is adopted.