Question

2. What is the difference between expected shortfall and value at risk? What is the theoretical advantage of expected shortfall over value at risk?

Answer 1

difference between expected shortfall and value at risk

Value at risk is defined as the loss level that will not be exceeded with a certain confidence level during a certain period of time. For example, if a bank's 10-day 99% VAR is $3million, there is considered to be only a 1% chance that losses will exceed $3 million in 10 days.

a measure that produces better incentives for traders that VAR is expected shortfall. This is also sometimes referred to as conditional VAR, or tail loss. where VAR asks the question 'how bad can things get'? expected shortfall asks 'if things do get bad; what is our expected loss?;

Theoretical Advantage of expected shortfall over value at risk

Expected shortfall talks about the expected loss in a given period of time. It estimate the value in a conservative way focusing on less profitable outcomes. The portfolio is created in a way that loss is not unlimited unlike with VAR.