Market risk management in a post-Basel II regulatory environment

Drenovak, Mikica, Ranković, Vladimir, Ivanović, Miloš, Branko, Urošević and Jelic, Ranko (2017) Market risk management in a post-Basel II regulatory environment. European Journal of Operational Research, 257 (3). pp. 1030-1044. ISSN 0377-2217

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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.

Item Type: Article
Schools and Departments: School of Business, Management and Economics > Business and Management
Subjects: H Social Sciences
Depositing User: Joy Blake
Date Deposited: 31 Aug 2016 09:59
Last Modified: 10 Mar 2017 09:49
URI: http://sro.sussex.ac.uk/id/eprint/63060

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