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Market Risk Management in a Post-Basel II Regulatory Environment

Author

Listed:
  • Branko Uroševic
  • Mikica Drenovak
  • Vladimir Rankovic
  • Ranko Jelic
  • Milos Ivanovic

Abstract

We propose a novel method of Mean-Capital Requirement portfolio optimization. The optimization is performed using a parallel framework for optimization based on the Nondominated Sorting Genetic Algorithm II. Capital requirements for market risk include an additional stress component introduced by the recent Basel 2.5 regulation. Our optimization with the Basel 2.5 formula in the objective function produces superior results to those of the old (Basel II) formula in stress scenarios in which the correlations of asset returns change considerably. These improvements are achieved at the expense of reduced cardinality of Pareto-optimal portfolios. This reduced cardinality (and thus portfolio diversification) in periods of relatively low market volatility may have unintended consequences for banks’ risk exposure.

Suggested Citation

  • Branko Uroševic & Mikica Drenovak & Vladimir Rankovic & Ranko Jelic & Milos Ivanovic, 2016. "Market Risk Management in a Post-Basel II Regulatory Environment," CESifo Working Paper Series 6293, CESifo.
    • Handle: RePEc:ces:ceswps:_6293
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    References listed on IDEAS

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    1. Jeremy Berkowitz & James O'Brien, 2002. "How Accurate Are Value‐at‐Risk Models at Commercial Banks?," Journal of Finance, American Finance Association, vol. 57(3), pages 1093-1111, June.
    2. Santos, André A.P. & Nogales, Francisco J. & Ruiz, Esther & Dijk, Dick Van, 2012. "Optimal portfolios with minimum capital requirements," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 1928-1942.
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    4. Pritsker, Matthew, 2006. "The hidden dangers of historical simulation," Journal of Banking & Finance, Elsevier, vol. 30(2), pages 561-582, February.
    5. Branke, J. & Scheckenbach, B. & Stein, M. & Deb, K. & Schmeck, H., 2009. "Portfolio optimization with an envelope-based multi-objective evolutionary algorithm," European Journal of Operational Research, Elsevier, vol. 199(3), pages 684-693, December.
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    More about this item

    Keywords

    finance; market risk; Basel 2.5; GARCH; NSGA-II;
    All these keywords.

    JEL classification:

    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics

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