Expected Shortfall Essay

agency I describes the calculation ofVaR in its accomplished form. For illustrative purposes, Part I will describe parametric VaR on a Gaussian distri entirelyion. Part II summarizes known weaknesses in VaR, from inherent vex and estimation danger to VaRs failure to perform to a lower place extreme economic stress and VaRs failure to sate the theoretical constraints on coherent measurements of lay on the line. Part Ill describes how to calculate anticipate shortfall as an extension of conditional VaR.It further describes how expected shortfall, but not VaR, provides a coherent measure of risk. Part Ill hence reverses field. It explains how VaR, but not expected shortfall (or, for that matter, nearly every opposite general spectral measure of risk), satisfies the mathematical requirement of elicitability. Mathematical limitations on measures of risk therefore force regulators and bankers to choose in the midst of coherence and elicitability, between theoretically sound con solidation of diverse risks (on one hand) and reliable backtesting of risk forecasts against historical observations.Justin Smith Morrill Professor of Law, Michigan State University (effective July 1, 2013). This paper summarizes a presentation made on April 17, 2013, at Georgetown Law Centers colloquium on international financial regulation, conducted by Professor Christopher J. drummer. I pry comments by Adam Candeub and Jeffrey Sexton. Special thanks to Heather Elaine Worland Chen. Jim Chen paginate 1 Electronic copy availableConventional VaR kindred modern portfolio theory and the entire edifice of quantitative finance derived from those beginnings,l conventional value-at-risk analysis assumes that risk is rguably represents the most important legal document for evaluating market risk as one of several threats to the global financial system. Basel II identifies a version ofVaR analysis as that accords preferred tool for assessing banks exposure to market risk. 4 Authorities around the world fetch endorsed VaR, either as a regulator standard or as a best practice. Even absent regulatory compulsion, private firms routinely use VaR as an internal risk management tool, oftentimes directing traders to reduce exposure below the level prescribed by those firms own VaR limits.