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Explain the difference between value at risk and expected shortfall.

Question:

Explain the difference between value at risk and expected shortfall.

VaR:

This questions centers on the concept of portfolio risk, which can be measured in a variety of ways, including standard deviation of returns, value-at-risk, and expected shortfall (or tail value-at-risk).

Answer and Explanation:

Value-at-risk (VaR) is the loss level that will not be exceeded with a certain confidence level over a period of time. For example, a one-year 99% VaR of $10 million indicates a 1% chance that losses will exceed $10 million over a one-year period.

Expected shortfall, or tail value-at-risk (TVaR), is a measure of the expected loss, if the VaR threshold is pierced. In other words, if things go bad, how bad are they likely to go? TVaR, like VAR, is a function of two parameters, the confidence level (% based) and the time horizon. For illustration purposes, if the one-year 99% VaR is $10 million, the one-year 99% TVaR could be $30 million. This indicates a 1% chance that losses will be $30 million over a one-year period, should experience pierce the $10 million VaR threshold.


Learn more about this topic:

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How to Reduce Investment Risks

from Focus on Personal Finance: Online Textbook Help

Chapter 11 / Lesson 6
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