Risk Measurement And Management In A Crisis-Prone World

The current subprime crisis has prompted the authors to look again into the nature of risk at the tail of the distribution. In particular, the authors investigate the risk contribution of an asset, which has infrequent but huge losses, to a portfolio using two risk measures, namely Value-at-Risk (VaR) and Expected Shortfall (ES). While ES is found to mea-sure the tail risk contribution effectively, VaR is consistent with intuition only if the underlying return distribution is well behaved. To facilitate the use of ES, they present a power function formula that can calculate accurately the critical values of the ES test statistic. This in turn enables them to derive a size-based multiplication factor for risk capital requirement.