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Backtesting Expected Shortfall - A Practical Guide

Expected shortfall (ES) has attracted controversy as a measure of a portfolio’s risk since it was introduced in 2001. One reason for this was that some critics suggested ES could not be backtested. Last year, however, MSCI proposed a way of backtesting expected shortfall. This development is especially important in the light of the Basel Committee on Banking Supervision’s recent decision to adopt ES in place of VaR. The ability to backtest expected shortfall also has broader implications, given the widespread use of the measure across the financial industry.