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Risk Horizon and Rebalancing Horizon
Abstract
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
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