Equilibrium Impact of Value-At-Risk

We study in a general perspective the partial equilibrium incentives and the general equilibrium asset pricing implications of Value-at-Risk (VaR) regulation in continuous time economies with intermediate consumption, stochastic opportunity set, and heterogenous attitudes to risk. Our findings show that the partial equilibrium incentives of VaR regulation can lead banks to increase their risk exposure precisely in high volatility" states, because of an anticipatory effect of VaR constraints on the optimal hedging demand. In general equilibrium, VaR regulation affects equity volatility and equity expected returns ambiguously, depending on the given model dynamics and heterogeneity structure. On the other hand, VaR constraints tend to produce unambiguously lower interest rates and higher equity Sharpe ratios.