VaR constrained asset pricing with relative performance

- We propose an asset pricing model in which the Value-at-Risk (VaR) constrained agents care about relative performance.
- Concerns about relative performance lead less risk averse agent to take more risk.
- The more risk averse agent is less likely to hit the VaR constraint with the relative performance.
- Thus, relative performance improve the risk sharing in the financial market.
- The volatility is less likely to jump which means relative performance makes the economy more stable.

This paper shows that when Value-at-Risk constrained institutional investors care about their relative standings among the peer group, more risk averse investors would take more risk, which improves the risk sharing and lowers the volatility.