Risk Horizon and Rebalancing Horizon

We analyze the impact of portfolio rebalancing frequency on the measurement of risk

over a moderately long horizon. This problem arises from an incremental capital charge recently

proposed by the Basel Committee on Banking Supervision. The new risk measure calculates

VaR over a one-year horizon at a high confidence level and assigns different

rebalancing frequencies to different types of assets to capture potential illiquidity.

We analyze the difference between discretely and continuously rebalanced portfolios in a simple model of asset dynamics by examining the limit as the rebalancing frequency increases. This leads to alternative approximations at moderate and extreme loss levels. We also show how to incorporate multiple scales of rebalancing frequency in the analysis