Expected Shortfall Under a Model With Market and Credit Risks

Kin Bong Siu () and Hailiang Yang ()
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Kin Bong Siu: The University of Hong Kong
Hailiang Yang: The University of Hong Kong

Chapter 6 in Hidden Markov Models in Finance, 2007, pp 91-100 from Springer

Abstract: Summary Value-at-Risk (VaR), due to its simplicity and ease of interpretability, has become a popular risk measure in finance nowadays. However, recent research find that VaR is not a coherent risk measure and cannot incorporate the loss beyond VaR or tail risk. This chapter considers expected shortfall (ES) as an alternative risk measure. We consider a portfolio subject to both market and credit risks. We model the credit rating using a Markov chain. Thus our model can be treated as a Markovian regime-switching model. We also propose a weak Markov chain model which can take into account the dependency of the risks. Expressions for VaR, ES and numerical results are presented to illustrate the proposed ideas.

Keywords: Value at Risk; expected shortfall; market risk; credit risk; credit ranking; Markov chain; weak Markov chain; coherent risk measure (search for similar items in EconPapers)
Date: 2007
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DOI: 10.1007/0-387-71163-5_6

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