THE UNEXPECTED SHORTFALL: AN ALTERNATIVE RISK MEASURE

Abstract

The international prudential regulation standard – the Basel standards – introduces a substantial change to its market risk framework. The change is part of a comprehensive revision of the standard to address the weaknesses discovered during the global financial crisis (GFC) of 2008. One of the key changes is the replacement of Value-at-Risk (VaR) with Expected Shortfall (ES) as the primary risk measure in the framework. By incorporating the tail events, ES partially answers the concerns raised about the VaR during the GFC. However, ES as well lacks a mechanism to extrapolate the historical shocks. This paper proposes an alternative measure – unexpected shortfall (US) – which aims to serve as a better safety barrier for financial institutions. Based on the evidence from 3 conventional currency pairs (EUR/USD, USD/TRY, EUR/TRY) and 1 cryptocurrency pair (BTC/USD), the new measure displayed violations in a reasonably close range of the expected values and backtest analyses suggested that the incurred excessive losses for US are less than both VaR and ES.

Keywords

• Market Risk
• Capital Adequacy
• Value at Risk
• Expected Shortfall
• Basel IV
• FRTB

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