Protective shield deflecting a storm over a financial district, representing tail risk management.

Decoding Tail Risk: How to Protect Your Portfolio from Extreme Market Events

Mira Elwood in Business & Economy December 2025 • 4 min read.

"Understand and manage tail risk with insights on identifiability, elicitability, and backtesting for smarter investment decisions."

In today's volatile financial landscape, understanding and managing risk is more critical than ever. Among the various types of risk, tail risk—the risk of extreme, unexpected losses—presents a significant challenge for investors and financial institutions. Events like the 2008 financial crisis or the recent pandemic serve as stark reminders of the potential devastation that tail events can unleash on portfolios and the broader economy.

Tail risk measures are designed to quantify the potential losses that could occur beyond a certain threshold or quantile of a distribution. These measures, which include Value-at-Risk (VaR) and Expected Shortfall (ES), have become standard tools in global banking and insurance regulatory frameworks, shaping how financial institutions assess and mitigate their exposure to extreme events. However, the effectiveness of these measures hinges on their identifiability (uniqueness) and elicitability (statistical tractability).

In a recent study, researchers Tobias Fissler, Fangda Liu, Ruodu Wang, and Linxiao Wei delve into the intricate world of tail risk measures, offering new insights into their identifiability and elicitability. Their work not only enhances our theoretical understanding of these measures but also provides practical guidance for model fitting, comparison, and validation. This article unpacks their findings, explaining the core concepts and implications for investors and risk managers.

What are Tail Risk Measures and Why Do They Matter?

Protective shield deflecting a storm over a financial district, representing tail risk management.

Tail risk measures focus on the extreme ends of a probability distribution, helping to answer the question: “What are the potential losses if things go really wrong?” Unlike standard deviation, which considers all deviations from the mean, tail risk measures specifically target the magnitude of losses beyond a set threshold. This makes them invaluable for anyone concerned about catastrophic events.

Two of the most common tail risk measures are:

Value-at-Risk (VaR): Represents the maximum loss expected over a given time horizon at a specified confidence level. For example, a 99% VaR of $1 million means there is only a 1% chance of losing more than $1 million.
Expected Shortfall (ES): Also known as Conditional Value-at-Risk (CVaR), ES calculates the expected loss given that the VaR threshold has been exceeded. It provides a more conservative and comprehensive view of tail risk than VaR alone.

These measures are not just academic concepts; they directly influence regulatory capital requirements for banks and insurance companies. Frameworks like Basel III/IV and Solvency II rely on VaR and ES to ensure financial institutions hold sufficient capital to withstand extreme losses. Therefore, understanding the properties and limitations of these measures is crucial for both regulatory compliance and sound risk management.

The Future of Tail Risk Management

The research by Fissler, Liu, Wang, and Wei provides a crucial step forward in understanding and applying tail risk measures. By establishing clear conditions for identifiability and elicitability, they pave the way for more robust model fitting, comparison, and validation techniques. As financial markets become increasingly complex and interconnected, these advancements will be essential for navigating uncertainty and protecting against extreme events. Whether you're an investor, risk manager, or policymaker, a deeper understanding of tail risk is no longer optional—it's a necessity for survival.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2404.14136,

Title: Elicitability And Identifiability Of Tail Risk Measures

Subject: q-fin.st math.st q-fin.rm stat.me stat.th

Authors: Tobias Fissler, Fangda Liu, Ruodu Wang, Linxiao Wei

Published: 22-04-2024

Everything You Need To Know

What exactly are 'tail risk measures' and why should investors be concerned about them?

Tail risk measures are designed to quantify potential losses beyond a specific threshold in a probability distribution. Unlike standard deviation, which considers all deviations from the mean, tail risk measures like Value-at-Risk (VaR) and Expected Shortfall (ES) specifically target extreme losses. Investors should be concerned because these measures help in understanding and mitigating the impact of catastrophic events on portfolios. Events like financial crises or pandemics highlight the importance of protecting against such extreme risks. Ignoring tail risk could lead to significant financial losses during unexpected market downturns.

Could you explain the difference between Value-at-Risk (VaR) and Expected Shortfall (ES), and why is Expected Shortfall considered more conservative?

Value-at-Risk (VaR) represents the maximum expected loss over a given time horizon at a specified confidence level. For example, a 99% VaR of $1 million indicates there is only a 1% chance of losing more than $1 million. Expected Shortfall (ES), also known as Conditional Value-at-Risk (CVaR), calculates the expected loss given that the VaR threshold has been exceeded. ES is considered more conservative because it provides a more comprehensive view of tail risk by considering the average loss beyond the VaR level, rather than just the threshold itself. VaR simply states a threshold, while ES quantifies the expected magnitude of losses beyond that threshold, offering a better understanding of the potential severity of tail events.

How do identifiability and elicitability impact the effectiveness of tail risk measures like VaR and ES?

Identifiability refers to the uniqueness of a tail risk measure, ensuring that the measure truly captures the specific risk it is intended to quantify. Elicitability concerns the statistical tractability of a measure, making it easier to perform statistical inference and model validation. Both identifiability and elicitability are crucial for the effectiveness of tail risk measures. If a measure lacks identifiability, it may not accurately reflect the underlying tail risk. If it lacks elicitability, it becomes challenging to compare models, fit them accurately, and validate their performance. The research by Fissler, Liu, Wang, and Wei provides conditions to enhance these properties, leading to more reliable risk management.

In what ways do regulatory frameworks such as Basel III/IV and Solvency II utilize tail risk measures, and why is this important for financial institutions?

Regulatory frameworks like Basel III/IV and Solvency II rely on tail risk measures, particularly Value-at-Risk (VaR) and Expected Shortfall (ES), to determine the capital requirements for banks and insurance companies. These frameworks ensure that financial institutions hold sufficient capital to withstand extreme losses, thereby maintaining financial stability. The use of VaR and ES in these regulations means that understanding the properties and limitations of these measures is not just an academic exercise but a critical component of regulatory compliance and sound risk management. This is important because it directly influences the amount of capital a financial institution must hold, impacting its profitability and overall risk profile.

What are the practical implications of the research by Fissler, Liu, Wang, and Wei for investors and risk managers concerned with tail risk?

The research by Fissler, Liu, Wang, and Wei provides crucial advancements in the understanding and application of tail risk measures. By establishing clearer conditions for identifiability and elicitability, they pave the way for more robust model fitting, comparison, and validation techniques. For investors and risk managers, this means that they can develop and use more reliable models to assess and manage tail risk. This leads to better-informed decisions about portfolio construction, hedging strategies, and risk mitigation, ultimately enhancing their ability to protect against extreme market events. As financial markets become more complex, these advancements are essential for navigating uncertainty and ensuring financial stability.