A Dual Characterisation of Regulatory Arbitrage for Coherent Risk Measures

Coherent risk measures alone are ineffective in constraining portfolio losses

“…We finally note that we are not the only authors to have identified that positive-homogeneity as a problematic property for a risk-measure. Herdegen and Khan (2020) have independently reached a similar conclusion by studying a concept which they term regulatory arbitrage, which is closely related to ρarbitrage. They define regulatory arbitrage as occuring when the problem of maximising expected return subject to ρ constraints becomes ill-posed.…”

“…The possibility of such ill-posed problems was first noticed by Alexander and Baptista (2002) in the case of VaR. See Herdegen and Khan (2020) for a review of the subsequent literature. While the existing literature focuses on the problem of maximising an expected return, and hence on the behaviour of risk-neutral agents, we consider the further dangers posed by agents which are tail-riskseeking.…”