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Managing Extreme Financial Risk by Karamjeet Paul

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Chapter 8

A New Measure for Effective Sustainability Management

Probable Maximum Loss

Abstract

A measure of exposure from extreme tail risk—Probable Maximum Loss (PML)—is defined as the maximum possible loss, mitigated by reliable, predefined, and structural actions and safeguards to reduce, prevent, or offset the loss. An example shows calculations of PML for a financial institution. PML has three significant advantages: (i) PML can be used to measure potential extreme losses from all categories of risk, thus providing for a relative comparison on a common scale; (ii) PML does not involve hard-to-understand, black-box analysis or subjective assumptions, making it a simple, transparent, and objective measure of complex models; (iii) PML provides ...

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