Agent-based risk management – a regulatory approach to financial markets
Abstract
Purpose
The purpose of this paper is to provide market risk calculation for an equity-based trading portfolio. Instead of relying on the purely stochastic internal model method which banks currently apply in line with the Basel regulatory requirements, the author also propose including alternative price mechanisms from the financial literature in the regulatory framework.
Design/methodology/approach
For this purpose, a financial market model with heterogeneous agents is developed, capturing the realistic feature that parts of the investors do not follow the assumption of no arbitrage, but are motivated by behavioral heuristics instead.
Findings
Although both the standard stochastic and the behavioral model are restricted to a calibration including the last 250 trading days, the latter is able to capitalize possible turbulence on financial markets and likewise the well-known phenomenon of excess volatility – even if the last 250 days reflect a non-turbulent market.
Practical implications
Thus, including agent-based models in the regulatory framework could create better capital requirements with respect to their level and counter-cyclicality.
Originality/value
This in turn could reduce the extent to which bubbles arise, since market participants would have to anticipate comprehensively the costs of such bubbles bursting. Furthermore, a key ratio is deduced from the agent-based construction to lower the influence of speculative derivatives.
Keywords
Acknowledgements
The author would like to thank the whole IMK research team and the participants of the 4th annual meeting of the academy of behavioral nance and economics for helpful comments and suggestions. The author also thank Sabine Kurzböck and Matthias Minke for excellent research assistance.
Citation
Theobald, T. (2015), "Agent-based risk management – a regulatory approach to financial markets", Journal of Economic Studies, Vol. 42 No. 5, pp. 780-820. https://doi.org/10.1108/JES-03-2013-0039
Publisher
:Emerald Group Publishing Limited
Copyright © 2015, Emerald Group Publishing Limited