A Breakthrough Idea in Risk Measure Validation – Is the Way Paved for an Effective Expected Shortfall Backtest?

Abstract

This research note is a kind of “call for attention” to recent developments in backtesting financial risk measures. This topic is relevant in relation to the regulatory monitoring of the performance of internal risk models used by banks in determining the minimum capital requirements for trading book portfolios. Backtesting is a process for checking the validity of risk estimation models. In his seminal work, Gneiting (2011) has proven that a prominent risk measure, Expected Shortfall (ES), lacks a property called elicitability. This finding has triggered a huge controversy on the issue of whether ES is backtestable at all. Due to the significant contribution of Acerbi and Szekely (2017, 2019) among others, the above-mentioned debate can be adequately and convincingly closed because there is a (re)solution. In particular, one can arrive at the conclusion that, building on its joint elicitability with Value-at- Risk (VaR), it is possible to introduce a so-called ridge backtest for ES. In fact, there is still an open question as to when and how the regulatory authorities will (re)act.