On a subjective approach to risk measurement

Piotr Jaworski

Quantitative Finance, 2006, vol. 6, issue 6, 495-511

Abstract: This study is based on the analogy between hedging a risky asset and keeping reserves to meet an unknown demand. The optimal hedging level, which depends on individual preferences, is regarded as a measure of risk. We determine the set of optimal levels and investigate the properties of the associated risk measures. This approach provides a new insight into Value at Risk (VaR). We consider it as a solution of a certain optimal inventory problem with linear cost and loss functions. We show that these functions determine the confidence level of VaR. In this way we obtain a simple model that helps us to choose a proper confidence level α and explains why supervisory institutions (such as the Basle Committee) choose a higher α than financial institutions themselves.

Keywords: Risk measures; Value at Risk; Inventory theory; Stochastic optimization; Convex analysis (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (2)

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DOI: 10.1080/14697680600739120

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