Systemic riskThe recent financial crisis made it clear that a 'mono risk approach' on a sole risk-object (mortgage, fund-investment) is insufficient.
Investments and loans are embedded in a worldwide sea of connected financial instruments and reinvestments. Systemic risk has to be included in our models.
Main challenge here is that systematic risk essentially depends on macroeconomic and (mostly) irrational factors. Further, systemic risk is related to the structure and dynamics of the market. More than numbers.....
Supervisory Herding RiskIn their effort to control and support financial institutions like banks, pension funds and insurance companies, country supervisors, regulators and 'accounting standards boards', defined a meticulously set of guidance rules (Basel I/II/II, Solvency I/II, Qis-I-V, IFRS, FAS, AIFMD, FTK, FIRM, etc.,etc.)
Without a sound own (board) risk vision that would undoubtedly have included some extra safety on 'company specific risk issues', financial institutions became - like a herd - all in the same way extremely vulnerable to (less defined) external risks.
Overregulation increases Herding Risk
Financial institutions all measure and respond to regulated risks in the same way. Supervisory Herding Risk is born.....
Too Much Focus RiskAs a consequence of pre-subscribed risk categories and ruling by law or (accounting) standards, there's the risk of 'too much focus' on specific risks while forgetting, denying or neglecting other important risks. Remember, the devil is in the (correlating) details....
Here's a useful, but not exhaustive, checklist to keep track on your risk models...
|Average Premium Risk||Diversification Risk||Matching Risk|
|Commodity risk||Employer Continuity Risk||Operational risk|
|Compliance Risk||Environmental Risk||Outsourcing Risk|
|Compliance Risk||Equity Risk||Oversight Risk|
|Concentration Risk||Herding Risk||Price Inflation Risk|
|Counterparty Risk||Interest rate risk||Property Derivatives Risk|
|Coverage Ratio Risk||IT Risk||Reinsurance Risk|
|Credit Risk||Legal risk||Reinvestment risk|
|Culture Risk||Legislative Risk||Reputation risk|
|Currency Risk||Liability Risk||Sex Calculation risk|
|Default Risk||Liquidity risk||Strategic risk|
|Deflation risk||Longevity Risk||System Risk|
|Disaster Risk||Market Risk||Systemic Risk|
|Discount Risk||Matching Risk||Wage Cost Inflation Risk|
ALM Simplifying RiskUnivariate models are killing and even multivariate models have proven to be too vulnerable and too limited in the recent crisis. It's not just about correlation and covariance matrices. What we need is an self-explaining model. A model that predicts or generates expected values in an economic context, depending on exogenous economic variables like inflation rate, GDP-Level, etc. and that is based on the same structured historical economic data-set.
We need 'Asset Liability Modeling New Style' and not only Stress Testing or
advanced and excellent Crash Modelling as well explained by EMB.
The consequence of earthquakes (Japan, Australia), a possible country default (Ireland, Greece, Portugal, ..), political instability (Libya, Ivory Coast, ..), war threat (Vietnam,Iraq, ..), financial easing (US, Europe,...), on our economic system, prices and financial institutions seems substantial and - moreover- predictable.
More than just trying to catch and capitalize these kind of risks in our risk models, we need to develop (financial) mechanisms and products that can cope as best as possible with these kind of risks.
The Riskmap 2011, Managing Risk | Maximising Opportunity, offers a good description of the actual risks that influence our lives and risk models.
A nice example is the recent (unexpected) leading role that France took in action against Libya. 'Riskmap 2011' mentions the 'Arabic Poll 2010' that clearly shows (despite the lack of sympathy for president Sarkozy) the trust and sympathy for France. France clearly outperforms the US and president Obama unfortunately has lost the trust of the Arabic world... Take a look at the next slide summary (or the original complete pdf):
Arab Public Opinion Poll 2010 Summary
The Arabic poll shows that the prime minister of Turkey, Erdogan, has clearly gained the confidence and trust of the Arabic countries. With Ergodan, Turkey - at the cross road between East and West - takes a leading role in the 'World Risk Management Process'. Ergodan's Risk Philosophy, invented by the Turkish Foreign Minister Ahmet Davutoglu, is 'Zero Problems'.....
Perhaps that should be the philosophy of actuaries too...
ConclusionFrom now on 'Modeling Risk' is more than just a financial exercise.
It's building scenario's, mechanisms and products that can cope with this risky world. Success as actuary or risk manager!
- Committee (behaviour) assessment tool
- Control Risks:Riskmap 2011
- Arabic Poll 2010
- Supervisory Compliant
- Maplecroft Risk Maps
- EMB: How to Model a Crash (REVO)