Optimal portfolios with minimum capital requirements

► We propose a portfolio selection approach to optimize capital requirements. ► The policy finds the optimal balance between VaR measures and VaR violations. ► We confirm empirically that the proposed approach outperform competing ones. We propose a novel approach to active risk management based on...

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Bibliographic Details
Published inJournal of banking & finance Vol. 36; no. 7; pp. 1928 - 1942
Main Authors Santos, André A.P., Nogales, Francisco J., Ruiz, Esther, Dijk, Dick Van
Format Journal Article
LanguageEnglish
Published Amsterdam Elsevier B.V 01.07.2012
Elsevier
Elsevier Sequoia S.A
Subjects
Basel Accords
Capital
Capital requirements
Convex optimization
Financial theory
Investment
Multivariate GARCH
Out-of-sample evaluation
Penalties
Portfolio investments
Portfolio management
Portfolios
Regulation
Regulation of financial institutions
Risk adjustment
Risk assessment
Risk management
Stress testing
Studies
Value
Value-at-Risk
Violations
Stress testing
Convex optimization
G11
Out-of-sample evaluation
Multivariate GARCH
G32
Online AccessGet full text
ISSN0378-4266
1872-6372
DOI10.1016/j.jbankfin.2012.03.001

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Summary:► We propose a portfolio selection approach to optimize capital requirements. ► The policy finds the optimal balance between VaR measures and VaR violations. ► We confirm empirically that the proposed approach outperform competing ones. 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 risk-adjusted performance of the proposed approach is superior to that of minimum-VaR and minimum-stressed VaR portfolios.
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ISSN:0378-4266
1872-6372
DOI:10.1016/j.jbankfin.2012.03.001