Measuring the Risk of Large Losses
Abstract: Risk management is an important component of the investment process. It requires quantitative measures of risk that provide a metric for the comparison of financial positions. In this expository paper, we give an overview of risk measures. In particular, we contrast different risk measures with respect to their sensitivity to potentially large losses due to market wide shocks. The industry standard value at risk exhibits many deficiencies. It does not account for the size of the losses and may penalize diversification. We compare value at risk to alternative risk measures including average value at risk and the less well known but superior utility-based shortfall risk.
Keywords: Distribution-invariant risk measures, utility-based shortfall risk, average value at risk, value at risk, event risk, extreme events, extreme value distributions.
Published in: Journal of Investment Management, Vol. 6, No. 4, (Q4 2008), pp. 1-15.
Previously titled: Measuring the Risk of Extreme Events