Risk measures based on target risk profiles

Jascha Alexander, Christian Laudag\'e and J\"orn Sass

Papers from arXiv.org

Abstract: We address the problem that classical risk measures may not detect the tail risk adequately. This can occur for instance due to the averaging process when computing Expected Shortfall. The current literature proposes a solution, the so-called adjusted Expected Shortfall. This risk measure is the supremum of Expected Shortfalls for all possible levels, adjusted with a function $g$, the so-called target risk profile. We generalize this idea by using other risk measures instead of Expected Shortfall. Therefore, we introduce the concept of general adjusted risk measures. For these the realization of the adjusted risk measure quantifies the minimal amount of capital that has to be raised and injected in a financial position $X$ to ensure that the risk measure is always smaller or equal to the adjustment function $g(p)$ for all levels $p\in[0,1]$. We discuss a variety of assumptions such that desirable properties for risk measures are satisfied in this setup. From a theoretical point of view, our main contribution is the analysis of equivalent assumptions such that a general adjusted risk measure is positive homogeneous and subadditive. Furthermore, we show that these conditions hold for a bunch of new risk measures, beyond the adjusted Expected Shortfall. For these risk measures, we derive their dual representations. Finally, we test the performance of these new risk measures in a case study based on the S$\&$P $500$.

Date: 2024-09
New Economics Papers: this item is included in nep-ban and nep-rmg
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