Value-at-risk-based risk management: Optimal policies and asset prices

This article analyzes optimal, dynamic portfolio and wealth/consumption pol icies of utility maximizing investors who must also manage market-risk expo sure using Value-at-Risk (VaR). We find that VaR risk managers often optima lly choose a larger exposure to risky assets than non-risk managers and con sequently incur larger losses when losses occur. We suggest an alternative risk-management model, based on the expectation of a loss, to remedy the sh ortcomings of VaR. A general-equilibrium analysis reveals that the presence of VaR risk managers amplifies the stock-market volatility at times of dow n markets and attenuates the volatility at times of up markets.