Extreme Value Theory

Extreme Value Theory (EVT) is a statistical approach used to model and predict the probability of extreme events, such as financial market crashes, natural disasters, or other rare occurrences. EVT focuses on the tail ends of probability distributions, where the most severe outcomes are observed, helping assess risks that traditional models may underestimate. This theory is widely used in finance, insurance, environmental studies, and risk management to understand and prepare for catastrophic events. EVT helps organizations evaluate the likelihood and potential impact of rare but highly consequential events, improving decision-making in uncertain and high-risk environments.

Example

Financial institutions use EVT to model the risk of extreme market downturns, enabling them to set aside capital reserves to mitigate potential losses.