Risk Management Failures
8 important questions on Risk Management Failures
Why does a large loss not necessarily be a failure in risk management?
What is the role of risk management?
What is easily forgotten with large losses?
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What are then risk management failures?
- Failure to take into account risks (ignored or unknown)
- Failure in communicating the risks to management (UBS)
- Failure in monitoring risks (change/move is too fast)
- Failure in managing risks (no hedge possible)
- Failure to use appropriate risk metrics (VaR does not see the tail)
How to mismeasure (known) risks?
- Correlation (benefit of diversification falls when correlations increase)
- Correlations increase in crisis (no historical data included?)
- Different distribution (not binomial)
- Risks that not have been manifested yet (science to art), prone to subjectivity. As risk management moves away from established quantitative models, it becomes easily embroiled in intra-firm politics.
Lesson: outcome should more rely on risk appetite and culture than risk management models.
How to mismeasure (ignored) risks?
- Somebody knows about a risk, but it wasn't captured in the models. Could also be mistakes in information collection. Danger for moral hazard on traders. Business risks are known but not always considered relevant (regulatory).
- Realisation of a truly unknown risk (investigating also costs money)
- Relying on past data (no hurt in previous crisis)
How about unknown risks?
Lesson: some capital serves for unknown risks
How about communication failures?
Risk monitoring and management reduces to the basis of getting the:
- right information
- at the right time
- to the right people
- so that these people can make the most informed judgments possible
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