Optimal portfolios with minimum capital requirements

Andre Santos (), Francisco J. Nogales, Esther Ruiz () and Dick Van Dijk

Journal of Banking & Finance, 2012, vol. 36, issue 7, 1928-1942

Abstract: 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.

Keywords: Convex optimization; Multivariate GARCH; Out-of-sample evaluation; Stress testing (search for similar items in EconPapers)
JEL-codes: G11 G32 (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:36:y:2012:i:7:p:1928-1942

DOI: 10.1016/j.jbankfin.2012.03.001

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