Scenario-based Risk Evaluation

Abstract

Risk measures such as Expected Shortfall (ES) and Value-at-Risk (VaR) have been prominent in banking regulation and financial risk management. Motivated by practical considerations in the assessment and management of risks, including tractability, scenario relevance and robustness, we consider theoretical properties of scenario-based risk evaluation. We propose several novel scenario-based risk measures, including various versions of Max-ES and Max-VaR, and study their properties. We establish axiomatic characterizations of scenario-based risk measures that are comonotonic-additive or coherent and an ES-based representation result is obtained. These results provide a theoretical foundation for the recent Basel III & IV market risk calculation formulas. We illustrate the theory with financial data examples.