Capturing cash non-additivity and horizon risk via BSDEs and generalized shortfall

TL;DR

This paper develops advanced fully-dynamic risk measures using BSDEs and shortfall approaches to effectively capture cash non-additivity, horizon risk, and interest rate uncertainty in multi-scale horizon risk evaluation.

Contribution

It introduces the h-generalized shortfall risk measures, linking BSDE-based measures with dual representations and extending shortfall measures to account for cash non-additivity.

Findings

hq-entropic risk measures are part of the h-generalized shortfall family

Classical entropic risk measures are both shortfall and certainty equivalent

New dual representation connects these risk measures to fully-dynamic certainty equivalents

Abstract

Whenever dealing with horizons of different times scales, risk evaluation of losses may incur in both interest rate uncertainty and horizon risk as introduced in [11]. With the goal to capture both effects, we work with cash subadditive fully-dynamic risk measures. In this work we consider such measures obtained via the BSDE and the shortfall approaches. We stress that we consider BSDEs both with Lipschitz and quadratic drivers. We then introduce the hq-entropic risk measure on losses as an effective example of fully-dynamic risk measure serving the scope. Shortfall risk measures are extended to capture cash non-additivity. For our newly introduced h-generalized shortfall risk measures we provide a dual representation and we connect them to fully-dynamic certainty equivalent. To conclude, we can see that the hq-entropic risk measures on losses belong to the family h-generalized shortfall, but they are not of certainty equivalent type. We note that the classical entropic risk measure, besides being generated by a BSDE, is also both a shortfall and a certainty equivalent.