Expected shortfall and VAR: cracking the marginal allocations
Here, Apoorva Shende, Kyriakos Chourdakis, Amit Puniyani, Marc Jeannin, Alan Smillie and Eduardo Epperlein develop an enhanced method for estimating marginal value-at-risk using local linear regression. Their new method ensures additivity, leads to systematically lower estimation errors, and is shown to be applicable for marginal expected shortfall estimation
A major motivation for estimating marginal or component value-at-risk is to allocate VAR-based market risk and CVA (regulatory) capital measures of a portfolio to a sub-portfolio or a trade within the larger portfolio. While the current regulations mandate VAR-based capital measures, the upcoming Fundamental review of the trading book (FRTB) will require expected shortfall (ES) to replace VAR. However, we expect VAR to still be an important tool in portfolio risk management. Thus, the aim of
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