Explanation:
Expected shortfall is a risk measure that is used to quantify market risk, particularly for extreme events. These extreme events are typically the worst 0.1%, 1%, or 5% of possible future scenarios. The term 'extreme events' refers to those events that, despite having a very low probability of occurrence, can cause significant losses when they do occur. The expected shortfall is designed to provide a measure of the potential losses that could be incurred in these extreme scenarios. This measure is particularly useful in risk management as it provides a way to quantify the potential losses from extreme events, which can then be used to inform risk mitigation strategies.
Choice A is incorrect. While it is true that expected shortfall measures market risk for risky events, the measure typically focuses on possible future scenarios rather than past ones. The use of past scenarios would not accurately reflect the potential future risks that a financial institution may face.
Choice B is incorrect. Expected shortfall does measure market risk for extreme events, but it typically focuses on the worst 0.1%, 1%, or 5% of possible future scenarios, not as low as 0.01%. This choice overstates the level of precision with which expected shortfall can predict extreme events.
Choice D is incorrect. Similar to Choice A, this option incorrectly suggests that expected shortfall measures market risk based on past scenarios rather than potential future ones. Additionally, like Choice B, it also inaccurately states that expected shortfall considers as low as 0.01% of these past scenarios.
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Q.1554 Correlation risk is an important part of market risk which is typically measured with the help of Value at Risk concepts. Market risk indirectly integrates the correlation risk. Market risk is also measured using the expected shortfall, characterized as tail risk. Keeping this in mind, what is the purpose of the expected shortfall?
A
To measure market risk for risky events, typically for the worst 0.1%, 1%, or 5% of past scenarios.
B
It measures market risk for extreme events, typically for the worst 0.01%, 0.1%, or 1% of possible future scenarios.
C
It measures market risk for extreme events, typically for the worst 0.1%, 1%, or 5% of possible future scenarios.
D
It measures market risk for risky events, typically for the worst 0.01%, 0.1%, or 1% of past scenarios.