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Risk & Portfolio

Extreme Value Theory

Also called: EVT, peaks over threshold, tail modelling

Extreme value theory models the tail of a distribution directly rather than fitting the whole thing and hoping the tail follows. It uses only observations beyond a high threshold, which is the honest response to the fact that a normal fit is driven by ordinary days and says nothing useful about catastrophic ones. The trade-off is data scarcity: by construction there are few extremes, so tail parameter estimates carry wide error bars.

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