Working Paper

Accurate Evaluation of Expected Shortfall for Linear Portfolios with Elliptically Distributed Risk Factors

Abstract: We provide an accurate closed-form expression for the expected shortfall of linear portfolios with elliptically distributed risk factors. Our results aim to correct inaccuracies that originate in Kamdem (2005) and are present also in at least thirty other papers referencing it, including the recent survey by Nadarajah, Zhang, and Chan (2014) on estimation methods for expected shortfall. In particular, we show that the correction we provide in the popular multivariate Student t setting eliminates understatement of expected shortfall by a factor varying from at least 4 to more than 100 across different tail quantiles and degrees of freedom. As such, the resulting economic impact in financial risk management applications could be significant. We further correct such errors encountered also in closely related results in Kamdem (2007, 2009) for mixtures of elliptical distributions. More generally, our findings point to the extra scrutiny required when deploying new methods for expected shortfall estimation in practice.

Keywords: Expected shortfall; Elliptical distributions; Multivariate Student t distribution; Accurate closed-form expression;

JEL Classification: C46; G11;

https://doi.org/10.17016/FEDS.2016.065r1

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2017-02-03

Number: 2016-065

Pages: 16 pages