Expected shortfall
Also called CVaR — the average loss on the days that DO breach the VaR threshold. Captures the depth of the tail, not just where it begins. Always worse than VaR.
Expected shortfall, often referred to as CVaR, is a measure of risk that goes beyond the basic Value at Risk (VaR). While VaR tells us the worst expected loss over a certain period, expected shortfall gives us a more comprehensive picture by considering the average loss on the days when the losses exceed the VaR threshold. This means it doesn't just tell us where the risk starts, but also how severe the risk can be. For instance, if you're investing in stocks listed on the Nigerian Exchange (NGX) and you set a VaR of ₦100,000, expected shortfall will tell you the average loss you're likely to experience on the days when your losses go beyond that ₦100,000 threshold.
In Nigerian context, if you're thinking about investing in Treasury bills (T-bills) offered by the Central Bank of Nigeria (CBN) with a benchmark interest rate (MPR) of around 27.50%, expected shortfall can help you understand the potential average loss if the interest rates fluctuate significantly. It's like knowing not just if you might lose money, but how much you could lose on those bad days. This is particularly useful for retail investors who are trying to balance their investment portfolio between different asset classes.
When it comes to dividends, Nigerian investors should also be aware of the 10% withholding tax (WHT) that applies to dividend income. Expected shortfall can provide insights into the potential losses on dividend income, factoring in this tax. Similarly, for those who trade frequently, understanding the 10% capital gains tax (CGT) can be crucial. Expected shortfall can help you gauge the average loss you might incur on your investments after accounting for this tax, providing a clearer picture of your overall returns.
Why it matters: Understanding expected shortfall can be a game-changer for Nigerian retail investors. It allows you to make more informed decisions by providing a clearer picture of potential losses, beyond just the threshold. This can help you better manage your investment risks, whether you're dealing with stocks on the NGX, government T-bills, or navigating the complexities of tax regulations like WHT and CGT. By knowing the depth of the risk tail, you can better prepare for the worst-case scenarios, ensuring that you're not caught off-guard when the market takes a downturn.