Forward-Looking Tail Risk Measures
67 Pages Posted: 1 Feb 2017 Last revised: 17 Jun 2018
Date Written: June 5, 2018
We present an analytical framework for the forward-looking measurement of extreme market risk. In contrast to standard techniques relying on past return data, we propose to extract Value-at-Risk and Expected Shortfall under the physical measure from current option prices. Our empirical evidence suggests that the resulting estimates accurately capture the tail risk of the S&P 500 and that they quickly react to changing market conditions. Compared to dynamic tail risk forecasts driven by past returns, our forward-looking estimates are relatively higher during good times and lower during adverse economic conditions, which could reduce the amplification effects of conventional dynamic risk management policies.
Keywords: Tail Risk, Options, Risk Management, Value-at-Risk, Expected Shortfall
JEL Classification: G12, G20, G31
Suggested Citation: Suggested Citation