How is Conditional Value at Risk (CVaR) different from VaR?

Conditional Value at Risk (CVaR) is defined as the expected loss on the portfolio or investment given that a loss has occurred beyond the Value at Risk (VaR) threshold. Essentially, while VaR provides a specific quantile of potential losses (for instance, the worst loss that will occur with a certain confidence level, such as 95% or 99%), CVaR goes a step further by focusing on the average of those losses that exceed this threshold. It helps risk managers understand the tail end of the loss distribution and provides insights into the behavior of losses in extreme scenarios.

This characteristic of CVaR is particularly important in risk management because it enables practitioners to assess the potential severity of losses during adverse conditions, ultimately guiding decisions on capital reserves or risk mitigation strategies. Understanding that CVaR offers a more comprehensive view of extreme risk exposures helps analysts make more informed decisions regarding portfolio construction, risk appetite, and stress testing.