On the Use of Long-Term Risk Measures as an Approach to Communicating Risks
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Jiandong Ren
Abstract
Value at risk (VaR) is a widely used measure for financial risks. However, as argued in Taleb (2012), “VaR encourages low volatility, high blowup risk taking which can be gamed by the Wall Street bonus structure.” It was also argued that one reason for this is the limited ability of all quantitative risk measures (including VaR, TVaR and many other modifications) to measure the risk of extreme events (black swans). In this paper, we argue that VaR and its modifications, being short–term in nature, intend to measure extreme risk by creating extreme small probability values. Even if accurate, they might not be effective in communicating risk to people because it is well documented in the psychology literature that humans tend to make irrational decisions when dealing with extreme small probabilities. As such, we propose that long-term risk measures, such as ruin probabilities over a long time horizon, provide a natural approach to avoid small probability values in measuring the risk of extreme events. They could be considered as a vehicle to communicate extreme risks to fund managers, insurance companies, as well as the public, and to help them in making decisions under uncertainty.
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©2016 by De Gruyter
Articles in the same Issue
- Frontmatter
- Featured Articles
- Forecasting Mortality using Imputed Data: The Case of Taiwan
- On the Bayesian Risk Evaluation of Minimum Guarantees in Variable Annuities
- On the Use of Long-Term Risk Measures as an Approach to Communicating Risks
- Effective Structure of Reinsurance Function for Disaster Risk in the Asia-Oceania Region
- Forecasting Thai Mortality by Using the Lee-Carter Model
- Long-Term Care: Is There Crowding Out of Informal Care, Private Insurance as Well as Saving?
Articles in the same Issue
- Frontmatter
- Featured Articles
- Forecasting Mortality using Imputed Data: The Case of Taiwan
- On the Bayesian Risk Evaluation of Minimum Guarantees in Variable Annuities
- On the Use of Long-Term Risk Measures as an Approach to Communicating Risks
- Effective Structure of Reinsurance Function for Disaster Risk in the Asia-Oceania Region
- Forecasting Thai Mortality by Using the Lee-Carter Model
- Long-Term Care: Is There Crowding Out of Informal Care, Private Insurance as Well as Saving?
