Measuring and regulating extreme risk

Ulf Nielsson (School of Business, Reykjavik University, Reykjavik, Iceland Columbia University, New York, New York, USA)

Journal of Financial Regulation and Compliance

ISSN: 1358-1988

Publication date: 8 May 2009

Abstract

Purpose

The purpose of this paper is to discuss two important extensions to the well‐known value‐at‐risk (VaR) methodology, namely extreme value theory (EVT) and expected shortfall (ES). Both of these extensions address the weaknesses of VaR, in particular the methodology's tendency to systematically underestimate risk of extreme market events.

Design/methodology/approach

The theory of VaR and the two extensions are reviewed and the methodology is evaluated in light of the Basel II regulatory framework that calls for the use of VaR by financial institutions.

Findings

The paper clarifies the use of VaR and its extensions to make practitioners more aware of the pitfalls and how to address them. It is recommended that the two extended measures of extreme event risk (i.e. EVT and ES) be included into every risk manager's information pool.

Originality/value

A compact review of these approaches and their regulatory connection has not previously been compiled. This review is of particular value to risk managers and policy markers given the turbulent market conditions of the past year.

Keywords

Citation

Nielsson, U. (2009), "Measuring and regulating extreme risk", Journal of Financial Regulation and Compliance, Vol. 17 No. 2, pp. 156-171. https://doi.org/10.1108/13581980910952595

Download as .RIS

Publisher

:

Emerald Group Publishing Limited

Copyright © 2009, Emerald Group Publishing Limited

Please note you might not have access to this content

You may be able to access this content by login via Shibboleth, Open Athens or with your Emerald account.
If you would like to contact us about accessing this content, click the button and fill out the form.
To rent this content from Deepdyve, please click the button.