Expected shortfall a tall order

• Published in: Risk (London. 1987) 2014-06, p.32
• Main Author: Carver, Laurie
• Format: Magazinearticle
• Language: English
• Subjects: Banking industry; Banks; Committees; Cost control; Feedback; International; Reforms; Regulation of financial institutions; Risk management
• ISSN: 0952-8776

Value-at-risk (VAR) has become so ingrained in financial risk management over the past 20 years that the committee's plan to replace it -- revealed in the initial January 2012 version of its Fundamental review of the trailing book -- caused a storm. VAR has the advantage of being intuitive; it is the biggest loss that can be suffered at a given confidence level. Expected shortfall is, roughly speaking, the average of the distribution potential losses above the VAR level. While that is easy to say, and most quants should be comfortable with the concept, critics warn it will not be so simple to rewire 20 years' worth of systems, reprogramme 20 years of back-testing routines or unlearn 20 years of directors' education. And quickly, too. Mercifully, the Basel Committee has signalled it will not require a separate test, only the extension of the VAR test deeper into the tail, but this will still mean more data work.