Market Risk Management in a Post-Basel II Regulatory Environment

Branko Uroševic, Mikica Drenovak, Vladimir Rankovic, Ranko Jelic and Milos Ivanovic

No 6293, CESifo Working Paper Series from CESifo

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.

Keywords: finance; market risk; Basel 2.5; GARCH; NSGA-II (search for similar items in EconPapers)
JEL-codes: C01 (search for similar items in EconPapers)
Date: 2016
New Economics Papers: this item is included in nep-rmg
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