On the Necessity of Five Risk Measures

TL;DR

This paper analyzes the limitations of using Value at Risk in banking risk management, compares alternative measures, and advocates for reporting multiple risk measures to improve risk assessment accuracy.

Contribution

It provides a detailed analysis of various risk measures, highlighting the importance of multiple measures for accurate loss distribution estimation and proposing regulatory reporting requirements.

Findings

Value at Risk has significant errors in risk estimation.

Alternative risk measures have distinct strengths and weaknesses.

Reporting multiple risk measures enhances risk assessment accuracy.

Abstract

The banking systems that deal with risk management depend on underlying risk measures. Following the Basel II accord, there are two separate methods by which banks may determine their capital requirement. The Value at Risk measure plays an important role in computing the capital for both approaches. In this paper we analyze the errors produced by using this measure. We discuss other measures, demonstrating their strengths and shortcomings. We give examples, showing the need for the information from multiple risk measures in order to determine a bank's loss distribution. We conclude by suggesting a regulatory requirement of multiple risk measures being reported by banks, giving specific recommendations.