IDEAS home Printed from https://ideas.repec.org/a/taf/quantf/v24y2024i1p83-104.html
   My bibliography  Save this article

Centred expected shortfall (CES): a traditional asset manager’s view on decomposing downside investment risk

Author

Listed:
  • Erik Kroon
  • Mehdi-Vincent Hacini
  • Koye Somefun

Abstract

Risk driver contributions are key to understanding portfolio risk. Often, this is done by decomposing portfolio volatility. This is problematic in the presence of non-elliptical distributions. Some asset managers propose switching to value-at-risk (VaR) or expected shortfall (ES) as risk measures. Often the latter is preferred as it deals better with risk in sub-portfolios. However, we argue that the traditional asset management industry should, as a rule, ‘not’ apply ES directly. Instead, expected portfolio return should be first subtracted from it; this Centred Expected Shortfall (CES) forms a natural extension of volatility. The relative breakdowns of both are identical if the underlying multivariate distribution is elliptical. From a practical perspective, we show how to correctly decompose CES and how ES can be misleading. Moreover, we recommend plotting so-called alpha-CES/volatility profiles. These work with distribution-free risk estimates and give a bird’s eye view on the downside impacts of any non-ellipticalities as a function of the portfolio’s left tail size (alpha). Conveniently, these profiles also describe upside tail (surplus) risks. We end with two practical illustrations: A simple assets-only example based on historical data with assets as risk drivers; and a more complex Liability-Driven Investing (LDI) simulation example with factors as drivers.

Suggested Citation

  • Erik Kroon & Mehdi-Vincent Hacini & Koye Somefun, 2024. "Centred expected shortfall (CES): a traditional asset manager’s view on decomposing downside investment risk," Quantitative Finance, Taylor & Francis Journals, vol. 24(1), pages 83-104, January.
  • Handle: RePEc:taf:quantf:v:24:y:2024:i:1:p:83-104
    DOI: 10.1080/14697688.2023.2269992
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1080/14697688.2023.2269992
    Download Restriction: Access to full text is restricted to subscribers.

    File URL: https://libkey.io/10.1080/14697688.2023.2269992?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:taf:quantf:v:24:y:2024:i:1:p:83-104. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Longhurst (email available below). General contact details of provider: http://www.tandfonline.com/RQUF20 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.