Analyzing the influence of Value at Risk on financial markets through agent-based modeling

Article type: Research Article

Authors: Takahashi, Hiroshi

Affiliations: Keio University, 4-1-1 Hiyoshi, Kohoku-ku, Yokohama-city, 223-8526, Japan. E-mail: htaka@kbs.keio.ac.jp

Abstract: This article describes the influence of risk management on financial markets. Institutional investors, such as pension funds, are legally required to follow a duty of care. Implementing adequate risk management is regarded as a central part of institutional investors' legal responsibilities and considered to be effective in terms of limiting investors' losses. The most prevalent risk management method is known as Value at Risk (VaR) and this is the focal point of my analysis. As a result of intensive agent-based modeling and experimentation, I have concluded that: (1) market prices could deviate from fundamental values when risk management criteria are too strict; (2) the larger the disparity of investors' estimations of stock prices becomes, the larger the tendency of deviation from fundamental values; (3) the same tendency can be observed under market conditions where heterogeneous investors trade. These results suggest that risk management which is required by law as a duty of care could contribute to market inefficiencies. If so, this is significant from both practical and academic points of view. Furthermore, I believe this paper proves the efficacy of agent-based modeling in analyzing the impact of certain regulations and laws on financial markets under realistic market conditions.

Keywords: Finance, risk management, duty of care, agent-based modelling

DOI: 10.3233/KES-130276

Journal: International Journal of Knowledge-based and Intelligent Engineering Systems, vol. 17, no. 4, pp. 257-266, 2013