Are there any serious drawbacks / weaknesses in the Euler allocation method, when used to allocate VaR capital (and potentially Expected Shortfall) to risk factors in a portfolio? I notice that recently people have started talking about Constrained Aumann Shapley (CAS) allocation approaches - does this offer advantages? Thanks.
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The biggest problem with Euler or CAS is that an explanation of where VaR/ES came from has to be so simple than even a bank regulator can understand it. :)
So everybody uses component, marginal, etc VaR/ES that have been around since the widespread Basel II VaR adoption in the 1990s. Regulators understand those.
More sophisticated tools may be useful for problems such as figuring out how a book might be tweaked to decrease its VaR; just don't show them to regulators who don't appreciate sophistication for sophistication's sake.
answered Nov 30, 2020 at 17:19
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$\begingroup$ I'm not sure I follow. My understanding is that i) both the Euler and CAS allocation methodologies consume the derivative of the risk measure (e.g. VaR/ES) w.r.t. the size of the holding of each component, and ii) this derivative is simply the component Var/ES. My question is not about ii) i.e. using component / marginal VaR / ES, but more about i) i.e. what are factors that affect the choice of allocation methodology (that consumes the component VaR). For example, are there differences in stability of Euler vs CAS, or is one better suited to non-linear portfolios, for example? $\endgroup$– MarcoNov 30, 2020 at 18:58