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When risk weights increase the risk: some concerns for capital regulation

Varsanyi, Zoltan (2009): When risk weights increase the risk: some concerns for capital regulation.

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Abstract

In this chapter I argue that as a response to the introduction of capital requirements in the form of risk weights investors might potentially choose riskier portfolios than before the regulation – this is, presumably, not what the regulation intends to achieve. That is, while regulation most likely diverts investors from their optimum decision it does not guarantee that the new optimum has a lower risk. The effect of the regulation depends on several things, most importantly the correlation between individual investments, investor preferences and the relative size of risk weights.

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