Impact of value-at-risk models on market stability

Financial institutions around the world use value-at-risk (VaR) models to manage their market risk and calculate their capital requirements under Basel Accords. VaR models, as any other risk management system, are meant to keep financial institutions out of trouble by, among other things, guiding in...

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Authors: Llacay Pintat, Bàrbara, Peffer, Gilbert
Format: article
Status:Versión aceptada para publicación
Publication Date:2017
Country:España
Institution:Universidad de Barcelona
Repository:Dipòsit Digital de la UB
OAI Identifier:oai:diposit.ub.edu:2445/114078
Online Access:https://hdl.handle.net/2445/114078
Access Level:Open access
Keyword:Mercat financer
Risc (Economia)
Gestió del risc
Variables (Matemàtica)
Financial market
Risk
Risk management
Variables (Mathematics)
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repository_id_str
spelling Impact of value-at-risk models on market stabilityLlacay Pintat, BàrbaraPeffer, GilbertMercat financerRisc (Economia)Gestió del riscVariables (Matemàtica)Financial marketRiskRisk managementVariables (Mathematics)Financial institutions around the world use value-at-risk (VaR) models to manage their market risk and calculate their capital requirements under Basel Accords. VaR models, as any other risk management system, are meant to keep financial institutions out of trouble by, among other things, guiding investment decisions within established risk limits so that the viability of a business is not put unduly at risk in a sharp market downturn. However, some researchers have warned that the widespread use of VaR models creates negative externalities in financial markets, as it can feed market instability and result in what has been called endogenous risk, that is, risk caused and amplified by the system itself, rather than being the result of an exogenous shock. This paper aims at analyzing the potential of VaR systems to amplify market disturbances with an agent-based model of fundamentalist and technical traders which manage their risk with a simple VaR model and must reduce their positions when the risk of their portfolio goes above a given threshold. We analyse the impact of the widespread use of VaR systems on different financial instability indicators and confirm that VaR models may induce a particular price dynamics that rises market volatility. These dynamics, which we have called `VaR cycles', take place when a sufficient number of traders reach their VaR limit and are forced to simultaneously reduce their portfolio; the reductions cause a sudden price movement, raise volatility and force even more traders to liquidate part of their positions. The model shows that market is more prone to suffer VaR cycles when investors use a short-term horizon to calculate asset volatility or a not-too-extreme value for their risk threshold.Elsevier B.V.2017info:eu-repo/semantics/articleinfo:eu-repo/semantics/acceptedVersionapplication/pdfhttps://hdl.handle.net/2445/114078Articles publicats en revistes (Matemàtica Econòmica, Financera i Actuarial)reponame:Dipòsit Digital de la UBinstname:Universidad de BarcelonaInglésVersió postprint del document publicat a: https://doi.org/10.1016/j.jedc.2017.07.002Journal of Economic Dynamics & Control, 2017, vol. 82, num. September, p. 223-256https://doi.org/10.1016/j.jedc.2017.07.002cc-by-nc-nd (c) Elsevier B.V., 2017http://creativecommons.org/licenses/by-nc-nd/3.0/esinfo:eu-repo/semantics/openAccessoai:diposit.ub.edu:2445/1140782026-05-27T06:46:51Z
dc.title.none.fl_str_mv Impact of value-at-risk models on market stability
title Impact of value-at-risk models on market stability
spellingShingle Impact of value-at-risk models on market stability
Llacay Pintat, Bàrbara
Mercat financer
Risc (Economia)
Gestió del risc
Variables (Matemàtica)
Financial market
Risk
Risk management
Variables (Mathematics)
title_short Impact of value-at-risk models on market stability
title_full Impact of value-at-risk models on market stability
title_fullStr Impact of value-at-risk models on market stability
title_full_unstemmed Impact of value-at-risk models on market stability
title_sort Impact of value-at-risk models on market stability
dc.creator.none.fl_str_mv Llacay Pintat, Bàrbara
Peffer, Gilbert
author Llacay Pintat, Bàrbara
author_facet Llacay Pintat, Bàrbara
Peffer, Gilbert
author_role author
author2 Peffer, Gilbert
author2_role author
dc.subject.none.fl_str_mv Mercat financer
Risc (Economia)
Gestió del risc
Variables (Matemàtica)
Financial market
Risk
Risk management
Variables (Mathematics)
topic Mercat financer
Risc (Economia)
Gestió del risc
Variables (Matemàtica)
Financial market
Risk
Risk management
Variables (Mathematics)
description Financial institutions around the world use value-at-risk (VaR) models to manage their market risk and calculate their capital requirements under Basel Accords. VaR models, as any other risk management system, are meant to keep financial institutions out of trouble by, among other things, guiding investment decisions within established risk limits so that the viability of a business is not put unduly at risk in a sharp market downturn. However, some researchers have warned that the widespread use of VaR models creates negative externalities in financial markets, as it can feed market instability and result in what has been called endogenous risk, that is, risk caused and amplified by the system itself, rather than being the result of an exogenous shock. This paper aims at analyzing the potential of VaR systems to amplify market disturbances with an agent-based model of fundamentalist and technical traders which manage their risk with a simple VaR model and must reduce their positions when the risk of their portfolio goes above a given threshold. We analyse the impact of the widespread use of VaR systems on different financial instability indicators and confirm that VaR models may induce a particular price dynamics that rises market volatility. These dynamics, which we have called `VaR cycles', take place when a sufficient number of traders reach their VaR limit and are forced to simultaneously reduce their portfolio; the reductions cause a sudden price movement, raise volatility and force even more traders to liquidate part of their positions. The model shows that market is more prone to suffer VaR cycles when investors use a short-term horizon to calculate asset volatility or a not-too-extreme value for their risk threshold.
publishDate 2017
dc.date.none.fl_str_mv 2017
dc.type.none.fl_str_mv info:eu-repo/semantics/article
info:eu-repo/semantics/acceptedVersion
format article
status_str acceptedVersion
dc.identifier.none.fl_str_mv https://hdl.handle.net/2445/114078
url https://hdl.handle.net/2445/114078
dc.language.none.fl_str_mv Inglés
language_invalid_str_mv Inglés
dc.relation.none.fl_str_mv Versió postprint del document publicat a: https://doi.org/10.1016/j.jedc.2017.07.002
Journal of Economic Dynamics & Control, 2017, vol. 82, num. September, p. 223-256
https://doi.org/10.1016/j.jedc.2017.07.002
dc.rights.none.fl_str_mv cc-by-nc-nd (c) Elsevier B.V., 2017
http://creativecommons.org/licenses/by-nc-nd/3.0/es
info:eu-repo/semantics/openAccess
rights_invalid_str_mv cc-by-nc-nd (c) Elsevier B.V., 2017
http://creativecommons.org/licenses/by-nc-nd/3.0/es
eu_rights_str_mv openAccess
dc.format.none.fl_str_mv application/pdf
dc.publisher.none.fl_str_mv Elsevier B.V.
publisher.none.fl_str_mv Elsevier B.V.
dc.source.none.fl_str_mv Articles publicats en revistes (Matemàtica Econòmica, Financera i Actuarial)
reponame:Dipòsit Digital de la UB
instname:Universidad de Barcelona
instname_str Universidad de Barcelona
reponame_str Dipòsit Digital de la UB
collection Dipòsit Digital de la UB
repository.name.fl_str_mv
repository.mail.fl_str_mv
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score 15,198674

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