On the Measurement of Economic Tail Risk

This paper attempts to provide a decision-theoretic foundation for the measurement of economic tail risk, which is not only closely related to utility theory but also relevant to statistical model uncertainty. The main result is that the only tail risk measure that satisfies a set of economic axioms for the Choquet expected utility and the statistical property of elicitability (i.e. there exists an objective function such that minimizing the expected objective function yields the risk measure) is median shortfall, which is the median of tail loss distribution. Elicitability is important for backtesting. We also extend the result to address model uncertainty by incorporating multiple scenarios. As an application, we argue that median shortfall is a better alternative than expected shortfall for setting capital requirements in Basel Accords.