On the Shortfall of Tail-Based Entropy and Its Application to Capital Allocation

We introduce and study the shortfall of tail-based entropy (STE), a tail-sensitive risk functional that combines expected shortfall (ES) and tail-based entropy (TE). Beyond the tail mean, STE imposes a rank-dependent penalty on tail variability, thereby capturing both the magnitude and variability of tail risk under extremes. The framework encompasses several shortfall-type measures as special cases, such as Gini shortfall, extended Gini shortfall, shortfall of cumulative residual entropy, shortfall of right-tail deviation, and shortfall of cumulative residual Tsallis entropy. We provide equivalent characterizations of STE, derive sufficient conditions for coherence, and establish monotonicity with respect to tail-variability order. As an application, we investigate STE-based capital allocation, deriving closed-form allocation formulas under elliptical and extended skew-normal distributions, along with several illustrative special cases. Finally, an empirical analysis with insurance company data illustrates the implementation and evaluates the performance of the allocation rule.

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Publication Details

Journal
Entropy
Published
2025-11-13
DOI
https://doi.org/10.3390/e27111153
Primary Topic
Risk and Portfolio Optimization
Type
article
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article

On the Shortfall of Tail-Based Entropy and Its Application to Capital Allocation

P. Li, Chuancun Yin
Entropy
Risk and Portfolio Optimization
article

On the Shortfall of Tail-Based Entropy and Its Application to Capital Allocation

P. Li, Chuancun Yin
article en

Abstract

We introduce and study the shortfall of tail-based entropy (STE), a tail-sensitive risk functional that combines expected shortfall (ES) and tail-based entropy (TE). Beyond the tail mean, STE imposes a rank-dependent penalty on tail variability, thereby capturing both the magnitude and variability of tail risk under extremes. The framework encompasses several shortfall-type measures as special cases, such as Gini shortfall, extended Gini shortfall, shortfall of cumulative residual entropy, shortfall of right-tail deviation, and shortfall of cumulative residual Tsallis entropy. We provide equivalent characterizations of STE, derive sufficient conditions for coherence, and establish monotonicity with respect to tail-variability order. As an application, we investigate STE-based capital allocation, deriving closed-form allocation formulas under elliptical and extended skew-normal distributions, along with several illustrative special cases. Finally, an empirical analysis with insurance company data illustrates the implementation and evaluates the performance of the allocation rule.

EntropyVol. 27(11)
Qufu Normal University (CN)
Openalex Percentile: Top 60%
Risk and Portfolio Optimization
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