Back-testing expected shortfall: mission possible?
Shifting from value-at-risk to expected shortfall in trading book capital rules makes back-testing difficult, or even impossible. Regulators say continuing to test VAR is sufficient, but that leaves out the tail – the main reason for the change. Laurie Carver reports
More conservative, but harder to check – that, in a nutshell, is the consensus on expected shortfall, the mooted replacement for value-at-risk as the basis for modelled trading book capital requirements. The question is whether a way can be found to back-test the measure and, if not, how big a problem that is.
Expected shortfall was proposed as a replacement for VAR in the Basel Committee on
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