An optimal investment and risk control policy for a bank under exponential utility

Ryle S. Perera*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

1 Citation (Scopus)

Abstract

Motivated by the Basel Capital Accord Requirement (CAR), we analyze a risk control portfolio selection problem under exponential utility when a banker faces both Brownian and jump risks. The banker's risk process and the dynamics of the risky asset process are modeled as jump-diffusion processes. Assuming that the constraint set of all trading strategies is in a closed set, we study the terminal utility optimization problem via the backward stochastic differential equation (BSDE) under risk regulation paradigm. We construct the BSDE by means of the martingale optimality principle, giving conditions for the corresponding generator to be well defined in order to derive the bounds on the candidate optimal strategy. We then construct an internal model for the bank under Basel III CAR, which is formulated from the total risk-weighted assets (TRWA's) and bank capital. The results obtained from this model can be adopted within the banking sector when setting up asset investment strategies and advanced risk management models, as advocated by the Basel III Accord.

Original languageEnglish
Pages (from-to)343-375
Number of pages33
JournalStochastic Models
Volume33
Issue number3
DOIs
Publication statusPublished - 2017

Keywords

  • Basel III capital accord
  • BSDE
  • capital adequacy ratio (CAR)
  • holomorphic function

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