Module: | MODULE B: RISK MANAGEMENT
Q357: Consider the following statements regarding Expected Shortfall (ES), also known as Conditional VaR, under the Fundamental Review of the Trading Book (FRTB) framework:
1. Expected Shortfall measures the mathematical average of all potential losses that exceed the Value at Risk (VaR) threshold in the extreme tail of the distribution.
2. Unlike VaR, Expected Shortfall satisfies the mathematical property of sub-additivity, making it a coherent and more reliable risk measure.
3. The FRTB framework explicitly replaced the 99% VaR metric with a 97.5% Expected Shortfall metric for calculating regulatory market risk capital.
2. Unlike VaR, Expected Shortfall satisfies the mathematical property of sub-additivity, making it a coherent and more reliable risk measure.
3. The FRTB framework explicitly replaced the 99% VaR metric with a 97.5% Expected Shortfall metric for calculating regulatory market risk capital.
✅ Correct Answer: D
The correct answer is D. Statement 1 is correct: Expected Shortfall (ES), or Conditional VaR, explicitly quantifies "tail risk." It answers the question: "If the VaR limit is breached, what is the expected average size of the loss?" Statement 2 is correct: In risk mathematics, a "coherent" risk measure must satisfy sub-additivity (the risk of portfolio A+B should not exceed the sum of individual risks). VaR fails this test under certain non-normal distributions, but ES consistently satisfies it.
Statement 3 is correct: A monumental shift in the Basel FRTB framework was replacing the 99% VaR metric with the 97.5% Expected Shortfall metric for regulatory capital calculations, forcing banks to hold capital against catastrophic, extreme tail events.
Statement 3 is correct: A monumental shift in the Basel FRTB framework was replacing the 99% VaR metric with the 97.5% Expected Shortfall metric for regulatory capital calculations, forcing banks to hold capital against catastrophic, extreme tail events.