Risk Management: A Helicopter View

1.     Concept of Risk

Risk  -> volatility of uncertain risk and uncertain gains -> risk take, profit gain. 
        -> 1. expected, can be well expected 2. unexpected (focus)
Risk Management :
A) manage expected risk
B) manage unexpected risk


Ultimately, determine the risk taking (take risk to gain)

 2.   Risk Management steps:

Identify-> evaluate exposure->propose method->develop strat -> reevaluate/readjust
Not perfect:
A)  fail to identify risk B) no proper method
3. Quantative measure:
VaR95 -> %95 confidence level of min loss or 95% significance level of max loss
Economic reserve:  ER =  ED*EP*ER , expected default rate* exposure*expected loss rate
To keep liquidity and avoid from bankruptcy


4. Qualitative measure:
Scenario analysis: eg. Worst case scenario analysis looking at macroeconomic scenarios on entity
Stress testing: stress on entity (shock factors etc)



 5.   ERM

Look at risk overall firm, apply quant and quality analysis, board of director decide risk appetite, review, audit and so on


6. Expected Loss vs Unexpected Loss
EL: normal course, single factor with statistics collected from history and can be mitigated with increasing charge, spread over
UL: unormal course, multi correlated factors, can be studied with hist data to gain some certainty


7. Risk And Reward
The more risk taken the more reward have, but reward has volatility.



 8.  Risks

  Market Risk:  market price/rate changes

  Interest rate risk, bond, unhedged, basis risk ( hedge not favorable)
  Equity Price risk , all market, secpecific ( diversify)
  FX Risk,  international interest rate
  commodity risk, sudden jump, black box
 

Credit Risk:  counterparty cannot settle

 Default risk: fail to pay, bond
Bankruptcy risk
 Downgrade risk： downgraded ->default
Settlement Risk:  in derivative (eg swap) losing party fail to pay


To mitigate:
Rate consider the risk taken, avoid concentration, avoid maturity concentration.



Liquidity risk

Funding risk: no money to pay, repurchase and etc
Liquidity risk: cannot buy/sell with lack of counterparty


Operation risk:
Internal process and unexpected and unavoidable external factors.



Legal and Regulatory Risk

Tax, orders laws and etc



Business Risk

Things with specific product ( eg, production-consumption relation）

 

Strategic Risk

Stupid board/management made stupid decision



Reputation Risk



Eg. Sanlu milk powder