Risk measures and the impact of asset price bubbles

Robert Jarrow and Felipe Bastos G. S Silva

Abstract

ABSTRACT

This paper analyzes the impact of asset price bubbles on a firm's standard risk measures, including value-at-risk (VaR) and conditional value-at-risk (CVaR). Comparing a bubble economy and a non-bubble economy, it is shown that asset price bubbles may cause a firm's traditional risk measures such as VaR and CVaR to decline. This decline is due to a reduced standard deviation and an increased right skew of the firm value's distribution due to bubble expansion. This effect on a firm value's moments due to the presence of price bubbles documents that traditional risk measures do not adequately capture the impacts of bubble bursting. We propose a new risk measure to account for losses associated with bubble bursting, a phenomenon that must be taken into consideration for the proper determination of equity capital. This additional risk measure is the expected holding period loss.