Backtesting Expected Shortfall A comparative empirical evaluation of different backtests

University essay from Lunds universitet/Nationalekonomiska institutionen

Abstract: This paper empirically evaluates whether different backtests for Expected Shortfall (ES) produce similar results. In 2016, the Basel Committee on Banking Supervision proposed a shift from Value-at-Risk (VaR) to ES as the industry standard when calculating capital requirements for banks. However, ES has been found difficult to backtest. Since backtesting results form the basis for determining the capital requirements of banks it is important to elucidate whether the backtests produce similar results. We answer this question by performing six different daily backtests on the S&P 500 index for the period 1965-2020 and measuring correlations between the different backtests. We found a substantial divergence across different backtests. We also found that the correlations remain stable or increase during the global financial crisis. In the light of these results we recommend practitioners to diversify between multiple backtests.

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