Expected loss

Imagine you are playing a game with marbles. Each time you play, you win or lose some marbles. Sometimes you might win a lot of marbles and sometimes you might lose some. Expected loss is a way to figure out how many marbles you can expect to lose on average over time.

Let’s say you play the game 10 times and you lose 2 marbles each time. Your expected loss would be 20 marbles (2 marbles lost per game x 10 games). But sometimes you might lose 1 marble, and other times you might lose 3 marbles. The expected loss is just an average of all the times you play the game.

Similarly, in the real world, companies calculate expected loss to predict how much money they might lose in certain circumstances (like if a customer defaults on a loan or if a natural disaster damages their property). By knowing their expected loss, they can prepare and set aside money to cover those losses.