The impact of risk regulation on price dynamics

Jon Danielsson, Hyun Song Shin and Jean-Pierre Zigrand

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Most financial risk regulations assume that asset returns are exogenous, where risk is estimated from historical data. This assumption fails to take into account the feedback effect of trading decisions on prices. We investigate the consequences of risk constrained trading by means of simulations of a general equilibrium model with a value-at-risk constraint and compare the results to the case when risk constraints are not present. Prices are lower on average in the presence of risk regulation, while volatility is higher. Risk regulation may have the perverse effect of exacerbating price fluctuations.

Keywords: Value-at-risk; Simulation; Basel II; Regulation (search for similar items in EconPapers)
JEL-codes: C15 G1 G18 (search for similar items in EconPapers)
Date: 2004-05
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (81)

Published in Journal of Banking and Finance, May, 2004, 28(5), pp. 1069-1087. ISSN: 0378-4266

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Journal Article: The impact of risk regulation on price dynamics (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:16628

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