Showing posts with label risk. Show all posts
Showing posts with label risk. Show all posts

Mar 30, 2014

Chief Actuary Officer

Let's take a look at the governance of financial institutions from a risk management perspective:

Governance Risk Management



Traditional governance focuses on the organisation-structure, decision-structure, influence and power-weights of all stakeholders. Governance Risk Management focuses on how to optimize and monitor risk and value creation for all stakeholders.

Financial Risk Management Monitoring
After defining a companies Mission, Risk Appetite and Strategic Plan, the year-targets and key indicators are not only translated into a tight budget (b) of 'sales targets' and 'profits', but also into 'balance sheet budget targets' (b).

It takes a real well defined 'Governance Risk Management' to split the balance sheet into such parts (Assets, Liabilities & Capital) that responsible officers in the company are able (and can take responsibility) to monitor the actual values (a) monthly or quarterly to the final or adjusted budget values (b).

  

Officer Role Division
In a well managed and structured financial company the risk-financial roles of the companies officers can be defined as follows:

  1. CIO
    The Chief Investment Officer is primarily responsible for managing the asset actuals A(a) versus the (adjusted) budget A(b). So the CIO has to manage [A(a)-A(b)] in terms of value and within defined  the investment risk budget.
     
  2. CAO
    Although often unremarked, an important part of the role of the Chief Actuary Officer is to manage the actual liabilities L(a) versus the (adjusted) Liabilities budget L(b).
    This is no easy job, as most longevity and (risk free) discounting of the liabilities are hard to influence.
    Wrapping up: The CAO is responsible for managing [L(a)-L(b)].

    Often the role of the CAO seems to be limited to insurers or pension funds. However, also banks need an actuarial officer, as more and more (product) risks on the bank's balance sheet become economic, demographic and bio-related (mortality, disability, lifestyle).  
     
  3. CRO
    Often the Chief Risk Officer is seen as someone at arms length reporting about risks to the (supervisory) board. However, one of the main roles of the CRO is to monitor Capital and Capital Requirements. He/She is responsible for realizing the sustainability of the company by managing the (adjusted) Capital budget C(b) while being confronted with continuously changinge Capital actuals C(a). So the CRO is responsible for monitoring [ [C(a)]-C(b)].  

AIRCO Management
Once the targets are set and responsibilities are defined, the hard part of managing a financial institution starts: Cooperation between the Actuarial, Investment, Risk and Capital Organisation (AIRCO) Chiefs.

During a budget year, all individual defined AIRCO budgets and actuals continuously change in practice.
As capital risk development is the complex result of Asset and Liability volatility, capital management and monitoring by (primarily) the CRO manager becomes extra complex. Especially in market crises situations (tail risks), where traditional (linear) correlations between AIRCO components fail by definition. It's the responsibility of the CRO to continuously balance between all stakeholders interests in narrow cooperation with the CAO and CIO, while staying on track with regulatory requirements.

This task is not easy, as AIRCO Management is not a one dimensional mission or game:
  • Run-off
    Often AIRCO Management is merely based on regulatory AIRCO requirements, based on run-off portfolios and one-year period confidence levels (e.g. 99.5% [Solvency-II] or 99,9% [ Basel-II/III] ).
     
  • Continuous business model 
    However this run-off approach is only based on a kind of default situation with a very low probability (< 1%). It's much more likely (> 99%) that a financial company will exist for more than one year.

    Therefore, adding one or more variations of 'continuous business model approaches' to the existing run-off approach on a board's table, will give the board a more (realistic) insight on the heavy an balanced decisions to be taken to continue and control a sustainable risk-return strategy. 

ALC-Team
To manage the complex of AIRCO effects, it's often helpful to set up an Asset Liability Capital Team (ALC-Team) within a financial institution. Main task of this team is to manage risk and returns across all AIC-axes in line with the strategic plan, the defined risk-return appetite and actual regulatory requirements.

The ALC-Team consists of the CAO, CIO an CRO and could in practice be chaired by the board's CFO, or CFRO.
This ALC-Team :
  • proposes board adjustments and monitors the risk-return targets and matching policy
  • makes clear what the often paradoxical and/or conflicting effects of risk-return management are for all stakeholders on basis of different future business continuity models (e.g. Run-off, Continuous business, etc.)
  • Makes clear and advises what measures the board can take due to the impact on ALC of different business models views, changes in economic risks and changes in regulation.
  • operates on basis of ALC reporting information,"Own Risk Assessment" reports, external Economic Risk Reports and external Regulatory Change Information.


Pitfalls
One of the most tricky pitfalls in capital management is that a financial institution tries to solve all budget variances and regulation changes only by adjusting its investment policy.

If adjusting is done 'on the fly', without considering the risk-return targets and (even worse) through the mental filter of just one of the stakeholders interests (e.g. 'shareholder value), a financial company implicitly risks to lose track of the overall strategic business targets.

If an economic or regulatory change influences the risk-return objectives, all possible instrumental options to respond, have to be taken into account. One of the most forgotten instruments to respond to market changes, is 'product management' or (new) 'product development'.

Yet, nevertheless the fact that existing (product) contracts are (short term) often hard to adapt, 'product management' is one of the most vital instruments to apply regarding the management of long term risk-return objectives.

Therefore AIRCO Management requires a planned an controlled Stakeholder Management Process in a financial institution.

Stakeholder Value (Risk) Management
Managing a company's stakeholder value implies that the effects of the economic, regulatory and own-company changes on the risk-return objectives are continuously balanced across all stakeholders (Shareholders, Clients, Asset Managers, Board/Employees).

Apart from 'HR value management', regarding possible board and employee reward and benefits adjustments, the instruments to manage and  balance Stakeholder Value:

A-1  Asset Value management
C-1. Capital Management
C-2  Shareholder Value management
L-1  Product Value Management
L-2  Client Value management

are presented in the next chart:

Conclusion
Managing a financial institution in this challenging financial decade (2010-2020) is a complex operation with multidimensional regulation and business risk-return targets. Financial Boards have to manage more truths at the same time in a highly volatile economic risk-return environment.

Surviving in this complex world urges boards to step from a traditional predictable managing approach to a more responsive managing approach, where stakeholders value is continuously monitored and adapted to the real world environment.

This new 'survival approach' urges to improve communication, process information and reporting across Assets, Liabilities and Capital Management within the organisation.

Establishing an ALC-Team approach could be a first step to improve the control on risk-return management within the organisation across all stakeholders and actively using all 'stakeholders value tools' in a balanced way.

Last but not least, the role of the Chief Actuary Officer should be more clearly defined. The CAO is, in line with Client Value objectives, primarily responsible for an adequate liability en product management, that's key in balancing the risk-return objectives of a financial institution.

Success!

Links/Sources
- Cartoon: Government Risk Management by Todd Nielsen
Risky Business – Making Phenomenal Decisions
   (While Not Forgetting the Risk)

Jun 28, 2013

Confidence Level Crisis

When you're - like me - a born professional optimist, but nevertheless sometimes worry about the unavoidable misery in the world, you ask yourself this question:

Why does God not act? 

Think about this question and try to answer it, before reading any further..



The answer to this question is very simple:

God does not act because he's conscious of everything  

The moral of this anecdote is that when you're fully aware of all the risks and their possible impact, chances are high you'll not be able to take any well-argued decision at all, as any decision will eventually fail when your objective is to rule out all possible risks.

You see, a question has come up that we can't agree on,
perhaps because we've read too many books.


Bertolt Brecht, Life of Galileo (Leben des Galilei)

On the other hand, if you're not risk-conscious at all regarding a decision to be taken, most probably you'll take the wrong decision.

'Mathematical Confident'
So this leaves us with the inevitable conclusion that in our eager to take risk-based decisions, a reasoned decision is nothing more than the somehow optimized outcome of a weighted sum of a limited number of subjective perceived risks. 'Perceived' and 'Weighted', thanks to the fact that we're unaware of certain risks, or 'filter', 'manipulate' or 'model' risks in such a way that we can be 'mathematical confident'. In other words, we've become victims of the "My calculator tells me I'm right! - Effect".

Risk Consciousness Fallacy
This way of taking risk based decisions has the 'advantage' that practice will prove it's never quite right. Implying you can gradually 'adjust' and 'improve' or 'optimize' your decision model endlessly.
Endlessly, up to the point where you've included so much new or adjusted risk sources and possible impacts, that the degrees in freedom of being able to take a 'confident' decision have become zero.


Risk & Investment Management Crisis
After a number of crises - in particular the 2008 systemic crisis - we've come to the point that we realize:
  • There are much more types of risk than we thought there would be
  • Most type of risks are nonlinear instead of linear
  • New risks are constantly 'born'
  • We'll not ever be able to identify or significantly control every possible kind of risk
  • Our current (outdated) investment model can't capture nonlinear risk
  • Most (investment) risks depend heavily on political measures and policy
  • Investment risks are more artificial and political based and driven, than statistical
  • Market Values are 'manipulable' and therefore 'artificial'
  • Risk free rates are volatile, unsure and decreasing
  • Traditional mathematical calculated 'confidence levels' fall short (model risk)
  • As Confidence Levels rise, Confidence Intervals and Value at Risk increase

Fallacy
One of the most basic implicit fallacies in investment modeling, is that mathematical confidence levels based on historical data are seen as 'trusted' confidence levels regarding future projections. Key point is that a confidence level (itself) is a conditional (Bayesian) probability .

Let's illustrate this in short.
A calculated model confidence level (CL) is only valid under the 'condition' that the 'Risk Structure' (e.g. mean, standard deviation, moments, etc.) of our analysed historical data set (H) that is used for modeling, is also valid in the future (F). This implies that our traditional confidence level is in fact a conditional probability : P(confidence level = x% | F=H ).

Example
  • The (increasing) Basel III confidence level is set at P( x ∈ VaR-Confidence-Interval | F=H) = 99.9% in accordance with a one year default level of 0.1% (= 1-99,9%).
  • Now please estimate roughly the probability P(F=H), that the risk structure of the historical (asset classes and obligations) data set (H) that is used for Basel III calculations, will also be 100% valid in the near future (F).
  • Let's assume you rate this probability based on the enormous economic shifts in our economy (optimistic and independent) at P(F=H)=95% for the next year.
  • The actual unconditional confidence level now becomes P( x ∈ VaR-Confidence-Interval) = P( x ∈ VaR-Confidence-Interval | F=H) × P(F=H) = 99.9% × 95% = 94.905%
Although a lot of remarks could be made whether the above method is scientifically 100% correct, one thing is sure: traditional risk methods in combination with sky high confidence levels fall short in times of economic shifts (currency wars, economic stagnation, etc). Or in other words:

Unconditional Financial Institutions Confidence Levels will be in line with our own poor economic forecast confidence levels. 



A detailed Societe Generale (SG) report tells us that not only economic forecasts like GDP growth, but also stocks can not be forecasted by analysts.


Over the period 2000-2006 the US average 24-month forecast error is 93% (12-month: 47%). With an average 24-month forecast error of 95% (12-month: 43%), Europe doesn't do any better. Forecasts with this kind of scale of error are totally worthless.

Confidence Level Crisis
Just focusing on sky high risk confidence levels of 99.9% or more is prohibiting financial institutions to take risks that are fundamental to their existence. 'Taking Risk' is part of the core business of a financial institution. Elimination of risk will therefore kill financial institutions on the long run. One way or the other, we have to deal with this Confidence Level Crisis.

The way out
The way for financial institutions to get out of this risk paradox is to recognize, identify and examine nonlinear and systemic risks and to structure not only capital, but also assets and obligations in such a (dynamic) way that they are financial and economic 'crisis proof'. All this without being blinded by a 'one point' theoretical Confidence Level..

Actuaries, econometricians and economists can help by developing nonlinear interactive asset models that demonstrate how (much) returns and risks and strategies are interrelated in a dynamic economic environment of continuing crises.

This way boards, management and investment advisory committees are supported in their continuous decision process to add value to all stakeholders and across all assets, obligations and capital.

Calculating small default probabilities in the order of the Planck Constant (6.626 069 57 x 10-34 J.s) are useless. Only creating strategies that prevent defaults, make sense.

Let's get more confident! ;-)

Sources/Links
- SG-Report: Mind Matters (Forecasting fails)
Are Men Overconfident Users?

Mar 17, 2013

AIFMD Fun of Funds

To prevent future crises, a new European law, the Alternative Investment Fund Managers Directive (AIFMD)  came into force on 22 July 2011.

The new directive has to be implemented before 22 July 2013 and will also apply to non-EU fund managers if they ares managing or marketing an AIF to investors in the EU.

It is believed that the directive will reduce the number of non-EU managers operating within the EU.

AIF's assets and risk management
Although the AIFM-Directive has many new demands (appoint independent valuer, custodian, disclosure) we'll focus here on the requirement to ensure an independent evaluation of the AIF's assets and risk management.

AIFMD Risk Management Obligations
  • Every AIFM needs to have an adequate documented risk management policy, covering all possible risks faced by the AIFs
  • Every AIFM has to set quantitative and qualitative risk limits for each AIF for all possible kind of risks 
  • An AIFM's Risk Measurement Procedure should include requirements for: backtesting, stress-testing, scenario analyses and the rules should describe remedial action plans when limits are breached. 

So far so good, peace of a cake, you would think. Unfortunately: NO!

1. In-depth market risk assessment: too complex and not adequate
An adequate in-depth market risk assessment of AIFMs AIFs actually requires a full 'fund of funds' transparency of the portfolio of the (AIF) funds.

The problem is that full 'fund of funds' transparency does not exist yet, nor can it finally be fully obtained. It's simply too complex:
  • undefined systemic risks are often beneath the analyse surface
  • (re)hedged risks could be part of a fatal unknown or unapparent self-reference hedge cycle
  • in-depth 'fund of funds' management is time consuming and presumes that risk profiles of sub-funds are available, when in practice they are often not

To illustrate the desperate, funny and useless efforts that are made to tame the 'fund of funds' issues within the AIFMD, just take a look at the next quote from the AIF Handbook draft 2013 :

Section 5-iii-1, Alias 'Fun' of Funds
"Any proposed investment by a Qualifying Investor AIF into another investment fund must be clearly disclosed.
Disclosure must focus on the implications of this policy regarding 
increased costs to unitholders (i.e. the fact that fees will arise at two or, in the cases where the underlying fund it itself a fund of funds, three levels – the Qualifying Investor AIF, the underlying fund of funds and the underlying funds in which the underlying fund of funds invests) and the resultant lack of transparency in investments."

I hope you're still with me after all this fund of funds of funds of funds fun..... ;-)

Thus, in-depth market risk assessments in a non transparent market are inadequate and may potentially result in ill-founded or even erroneous conclusions (e.g.' false safety').

Market Risk Assessment
The adequacy of an AIFMD's Market Risk Assessment could be roughly defined as:

MRA-Adequacy = ADTQ x RPQ x RMQ


With: ADTQ= Asset Data Transparency Quality, RPQ= Risk Policy Quality and RMQ = Risk Model Quality.

Just let your colleague rate your ADTQ, RPQ and RMQ on a ten point scale. If the outcome MRA-Adequacy is lower than 800, consider your test as inadequate.

As transparency also includes full sub-cycle  'fund of funds' transparency, often ADTQ will not score high enough for an adequate test outcome.

Example
Suppose an AIF consists of 30% 'fund of funds' with minor risk information regarding the sub-funds.All other scores of the AIF score well (10). In this case the test adequacy score is 700 (= 7 x 10 x 10) . Conclusion: the quality of your risk assessment is insufficient for drawing robust conclusions.

2. Alternative: Strategic Market Risk Assessment
Instead of - come what may - trying to get to the endless bottom of a 'fund to fund' construction, a more strategic risk assessment approach -  as an alternative -could work out much more effective. A strategic market risk assessment that assesses the nature, risk and policy of a AIF and its investments and that implicitly takes into account non-linear risks, the presence of systemic risk, a large number of weighted and not-weighted economic scenarios, stress tests and fat tail risks.

The Secret of the Chef
Many (hedge) funds have only a limited transparent investment policy or an investment policy that  - for whatever reason -is regarded as 'The Secret of the Chef'.

In these kind of funds 'full disclosure' will end in a lot of degrees of freedom in 'risk policy' and corresponding mandates.

It's important to realize that the more degrees of  freedom in 'risk policy' a manager of a fund has, the more risk will emerge in the above formulated alternative assessment.

New alternative market risk models?
Key question is: are there new models that can assess investment strategies and portfolios in a systemic risk environment and on basis of non-linear modeling.

The answer to this question is : Yes, very soon!

Symetrics, a brand new company in the Netherlands is developing an investment decision support and assessment system called SyMath, that is based on nonlinear modeling, grasps systemic risk and includes future crises. SyMath will be on the market mid 2013.



Until then will have to assess AIFMs with pen and pencil... ;-)


Links, Used Sources


Jan 20, 2013

SMPLFCTN

As an actuary, you probably grew up with that famous quote of Einstein:

Everything Should Be Made as Simple as Possible,
But Not Simpler.

However, as 'Quote Investigator' shows, there is no direct evidence that Einstein crafted this aphorism...

Hmmmm.... Never mind.... as this quote is clearly redundant and therefore can be simplified....

So, it's enough to stick to the subjective concept of 'keep it simple'.....

'Simple', simply means 'easy to understand'.  

If we would try to present or explain something 'too simple', we are in fact making it harder to understand and therefore 'more complicated'.

Example
If we try to explain that we can estimate the area of a circle (approx. 3.14159...; radius=1) in practice by a n-sided polygon, a three year old child ;-) will buy your simplification in case of  a 12-sided polygon.




Oversimplified, or Worse: Desimplified
In case of a square (4-sided polygon), he'll probably raise his eyebrow, as you oversimplified the topic. And in case of a triangle you'll probably have lost him completely. You desimplified and thereby complicated your case to the opposite of what you untended : a clear understanding.



Simplification Criterion
Keep in mind that, like in the case above, you must develop a criterion when you simplify things. In the above example, a criterion could (e,g) be that the area of the polygon shouldn't differ more than 10% of the original circle and must have a relative simple (round) answer. This criterion would lead to a 12-sided polygon as an adequate simplification example.


And of course, we have to test this ex-ante 12-sided criterion in practice by means of a questionnaire.


Simplification is Complicated
However, 'simplification' as process, is not simple at all. In practice simplification can be used to reduce things that are:
  1. complicated (not simple, but knowable) or 
  2. complex (not simple and never fully knowable) 
In an article called 'Simplicity: A New Model',  Jurgen Appelo tries to simplify the complex world of simplicity linked concepts. He states that simplification means 'make understandable', which means moving it vertically, from the top of the model to the bottom in the following Appelo-illustration.

Anyhow, there's much to learn about simplicity related topics.....   

Let's finish with an excellent example of a need for simplification : 

Simplifying 'Complexity of financial regulation'
In an excellent presentation, Executive Director Financial Stability of the Bank of England,  Andrew Haldane, pleas and argues to simplify financial regulation.

It turns out that the growing number of regulation rules and principles (e.g. Basel III) has an adverse effect on taming the crisis.

Also 
the traditional Merton-Markowitz approach that assumes a known probability distribution for future market risk and enables portfolio risk to be calculated and thereby priced and hedged, offers no help to solve the current crisis.
Haldane concludes that "More simple regulation  based on 'Optimal choice under uncertainty' is necessarily. Haldane concludes:

"Modern finance is complex, perhaps too complex.  Regulation of modern finance is complex, almost certainly too complex.  That configuration spells trouble.

As you do not fight fire with fire, you do not fight complexity with complexity.  Because complexity generates uncertainty, not risk, it requires a regulatory response grounded in simplicity, not complexity. 


Delivering that would require an about-turn from the regulatory community from the path followed for the better part of the past 50 years.  If a once-in-a-lifetime crisis is not able to deliver that change, it is not clear what will.  


To ask today’s regulators to save us from tomorrow’s crisis using yesterday’s toolbox is to ask a border collie to catch a frisbee by first applying Newton’s Law of Gravity.
"


Haldane's (2012) presentation called 'Ensuring Long-Term Financial Stability', or more popular 'The dog and the frisbee', is a breakthrough in managing, modeling and controlling Risk and financial future results. It's a MUST read for actuaries and board members in the financial industry.

Finally
From now in, actuaries can simply start 'helping' as a border collie!

Sources/Links
- BOE Presentatie Andrew Haldan
- Risk models must be torn up
- Mathematica: Play with Polygons
- Einstein's Simple Quote Investigated
- Complex versus Complicated
Complicated vs complex vs chaotic
- Simplicity a new model

Sep 14, 2012

Too Much of a Good Thing

We all know the expression "Too much of a good thing", but in practice, do we act in line with this life principle ?....... NO

I'll illustrate the fallacy of this "Too Much" principle with regard to two topics: Debt and Risk.

Debt
We all know that when it comes down to setting up a new business or investing in a sustainable development, a loan may help us to start up fast and facilitate growth.

So we might say that a deliberate chosen debt (a loan) stimulates the growth of a company or investment and also stimulates the entrepreneur or investor to take the 'right' decisions.

However when adding more debt (taking up more loans) doesn't generate the intented growth, in most cases a serious profit recovery plan is needed to keep the company a life or the investment profitable.

Unfortunately this is not the way we think in saving our western economy.

We keep adding debt while the growth of our economies keeps slowing down. This development is the main reason why the price of gold keeps rising.

Golden Proof
Although in 'normal' times the relationship between gold and country debt is not substantial, it's clear that in a 'no-growth increasing-debt policy' this relationship becomes clearly visible.

Despite of these clear signs, we keep adding debt-increasing measures, while the last signs op economic growth hope drown in the sea of debt.

When I showed the above slide on a Webinar (= online seminar) , one of the participants stated that investing in gold at this (current) price level would be risky.


I answered that the opposite was in fact true, as in historical perspective the market value of the Federal Reserve's Gold has fallen back to a backing up level of around 20-30% of the balance sheet.

So in fact the Fed has allocated 'too little of a good thing ' to restore trust in the financial markets.

In other words, Gold has still a great upward potential, as seen from a risk perspective.

Without going into 'too much' detail her, in fact, it's the other way around:


The relatively high price of Gold in Dollars,
is an indicator of the default risk of the Dollar. 

Looking at the dollar from this new perspective, it suddenly seems strange that we define the default risk of a country (currency) only with help of a country's (artificial) bond interest rate (more on my Blog: Default Risk at Risk) on basis of an also artificial  'risk free interest rate'.

Why not define the risk of a country's currency in terms of it's value to a neutral 'zero credit risk'  asset class, which gold in fact is.  I challenge you to come up with a new formula for the default risk of a country, based on the price of gold (e.g. London Fix=LF)... 



Default Rate Currency X = Dc = FLondon Fix [Currency] )

where Currency=USD, GBP or EUR and F is a function which translates the actual London Fix price of Gold in a specific currency to a default risk. 

If no formula-volunteers step up, I'll come up with formula in one of my next blogs.


Risk
Now let's look from a 
 "too much of a good thing perspective" at Risk itself.
As we all know, a positive and optimistic look at life increases the probability of success in life. In examining Risk, Risk-Life is different.

When risks are far away and have not yet occurred, risk professionals as well as non-risk-professionals are inclined to underestimate risk. On the other hand, risks that occur now and then are (too) well known and overestimated. Finally unkonwn  hidden risks in the well known high frequency-low-impact risks are again often underestimated.


The Art of Judging Risk
A professional risk manager is more than a good goalkeeper in a professional football (soccer) club.

His first responsibility is to identify and assess a potential risk
 together with his (management) team.

Golden rule in this risk assessment process is to estimate risk in such a way in time that you never get into a underestimated position of a specific risk.



This implies that when we assess new risks (e.g.  'hedge fund risks' or 'country default risks') we should not start from a zero risk position and adding risk in our models while we are making progress, but rather the other way around.

This way of estimating risks will contribute to a much more professional and appreciated working method in the risk work field.

Enjoy exploring risk management. It's an everlasting activity you can't do too much!  Or can you?

Used Sources
- Clipproject.info 



Aug 24, 2012

Humor: Penguin Risk Management

Life ain't easy ... sometimes.... Especially not... when you're a risk manager....

Changing Professional Field of Risk
In order to make any kind of progress in our human - penguin like - society, we'll have to take risk...

Part of a risk manager's task is to check regularly whether parties, (e.g.  asset managers)  are acting in line with the defined risk mandates (compliance). 

It's more or less generally accepted that a risk manager's first task is to prevent, control and optimize risks from a mainly defensive point of view.

However.....
we live in a 'risk growing world' where (state) regulators and accounting standard boards increasingly prescribe all kind of risk controlling measures.

In this world it becomes more and more important that a risk manager also advices actively on where and when to take more risk, instead of less risk.

Zero Risk Attitude: Death by Risk Management

Taking less and less risk gradually leads to a zero risk position.

An (on top of)  'zero risk attitude' of a risk manager can therefore become the nail in the coffin of any financial company. As without risk there's no profit, and without profit any financial company is doomed.

So skip any form of 'scary risk management', face risk as it is and changes in time. Moreover, develop and demand a positive, realistic and dynamic risk view of yourself and your professional environment.


Risk, Part of Evolution
History shows that taking major risks is essential in successful exploring new areas.

A few examples:
  • Discovering America
    The (re)discovering of America by Columbus took a lot of lives. Shipwrecks, bad weather, diseases and fights took its toll.
  • Radioactivity
    Discovering the properties and applications of radioactivity took many lives. Example : Marrie Curie died as a result of prolonged exposure to radiation.
  • Exploring Space
    Many astronauts died on the the Gemini, Apollo an shuttle projects About 5% of the astronauts that have been launched, have died.

Future Risk Space Programs: Dream Chasing
At the start of the Shuttle program, NASA managers thought (calculated?) there was only a '1-in-100,000' chance of losing a shuttle and its crew.
Today, engineers believe this probability was in fact closer to 1 in 100. 
NASA’s basic requirement for new commercial crew vehicles is a probability of 1 in 1000 (!).

On basis of these modern risk standards, the original Apollo project back in 1961 would not even have started.

Looking at our 'Exploring Space' ambitions, it's likely that due to higher risk standards, cost of new space programs will increase to a level where no profitable exploitation (at all) is possible.

In other words: Profitable exploitation of future crewed flights to other planets will turn out to be a real 'Dream Chaser'.

Let's be fair, after 1972 we've never been back to the moon. Yet, plans to go to Mars are presented as 'business as usual'....

At the same time risk standards increase and costs explode.
Forget about going to Mars at current risk standards!


Financial Risk Equivalent
Just like in the space industry, risk standards in the financial industry have increased. From old demands, like the 2.5% one year default rate (97.5% confidence level)  of Dutch pension funds to the 1.0% - 0.5% default rate in the insurance and 0.1% - 0.05% in the banking industry.


In general, raising default risk standards by lowering default levels is a dead end street. It's much more effective to tackle other risk topics like controlling 'systemic risk' and 'company size' and accept risk as a fact of life.

Penguin Behavior
Perhaps - regarding risk and size - we can learn from penguin behavior. Although king penguins are highly gregarious at rookery sites, they usually travel in small groups of 5 to 20 individuals.

Just like we humans, penguins have to take risk in order to survive. In our research for risk we have to accept risk, and therefore loss, as a necessary unavoidable part of (financial) life.
Let's learn from penguin Risk management.....

--------------------------------------------------------------------------------------------

Conclusion
Let's wrap up with penguin wisdom:
To survive as society on the long term, we need to create smal(ler) companies with a limited exposure to systemic risk and a higher risk attitude.

Risk is a part of life, explore but don't kill it, as it will kill you...


Links & Used Sources:
- Apollo by numbers
- Percentage of fatal space flights
- Analysis: NASA underestimated shuttle dangers 
- Certified Safe (2011)
- Dream Chaser
- POLE Penguins Comic Strip

Aftermath
Mars?  Perhaps in 2525?

Aug 4, 2012

Worldwide Country Bonds Overview

Country Bond Rates are decreasing. As global debt is still increasing, trust is declining. 'Counterparty Safe Cash'  is what's becoming more and more important. Prepare for getting used to negative interest rates!
BTW: If you can't hold your breath, go to the end of this blog and click one of the tabs to get an updated worldwide overview of actual country bond interest rates.


What's up?
Countries with a high inflation (e.g. Brazil, India, China) or countries (e.g. Portugal, Ireland, Spain) that can't control and therefore have to finance their increasing debt at high interest rates, still show optical interesting interest rates for investors... So it seems, as these relative high interest rates are in fact 'compensation for inflation' or 'hidden default premiums'.

And of course we have countries (e.g Greece), who's interest rates show that they have in fact gone broke.

Unfortunately non of the EU countries dares to pull the plug...  From a risk management perspective: Living in a nuclear financial death zone, apparently is a better option than pulling the trigger in the knowledge that not only your Greek brothers but also YOU will be 'financial dead' for sure.....

Still the Greeks get away with this non compliance strategy, let's call it:
Greek Risk Management

Last but not least we have the strong countries like Denmark and Germany with low interest rates. These countries have to carry and finance their weaker brothers short term. So it all comes down on cash and counterparty risk.

The rhetorical question in this European business case is:
Can Germany finance a Europe that fails to restructure their debts in a sustainable way?

Country Bond Interest Rates in alphabetical order
Let's examine those interest rates as reported by Bloomberg, at the end of July 2012 in alphabetical order:

It's clear that country bonds interest rates vary widely across countries.

White spots in the table imply, there's no (Bloomberg) data available.

Let's bring some order in this bond-muddle, by ranking the countries on basis of their 10Y Bond yield.

Country Bond Interest Rates sorted by '10Y' Bond Rate



From the above chart it is clearly visible that
  • Germany, Denmark and The Netherlands already enter the negative interest rate zone for 1 and 2 year bonds.
  • Greece, with a phenomenal interest rate, is is completely burned up
  • The Eurozone is split up in good and bad performing countries
  • A strong, sustainable and relatively independent country like Switzerland has 'low short term', as well as 'low long term' interest rates.
    This must for sure be a warning to every investor to estimate long term interest for other countries  much higher on the long term. Perhaps the relatively higher long term interest rates of other countries resembles the implicit (extra) inflation expectation on the long run.

Mattress Money
As debt keeps increasing, economic growth in western countries is limited and modest inflation continues, short term interest rates will stay low for the near future (until the end of time inflation beast is released).

With an increasing 'cash demand' from weak performing countries, we have to learn to get used to negative interest rates in relatively more strong performing countries.

In other words, consumers and professional investors have to pay to put their money in the bank. Why not keep your money under the mattress?

For consumers this might perhaps be a risky (theft) solution  to consider. Professional investors however, have to reduce counterparty risk which demands first class collateral assets.

Therefore "mattress money" is no option for professional investors and (increasing) negative interest is the price these investors will have to pay for keeping more and more cash as debt and risk keep rising.

Desperate advice ;-)
Perhaps - just like World War II was financed by War Bonds - we should appeal to private investigators and consumer to fund the government in their desperate war against debt.... government debt ...


 But then.... who would be willing to invest?
Are you interested in following the actual country bonds interest rates, than bookmark this blog or the special Actuary-Info Actual Country Bond Rates Page, and come back once in a while to view the latest bond interest developments by clicking on one of the next tabs (have a few seconds patience, loading 150 (!) bond rates takes some time).

Actual Country Bond Interest Rates (Alphabetical)



Actual Country Bond Interest Rates ('10Y' Sorted)


Update 2013 
Bloomberg stopped publishing a lot of bond rates. That's why several bond rates are missing. Sorry.


Hope you enjoyed this holiday blog...

Related Links/Sources

Jun 21, 2012

Gold as Investment

Financial institutions have to optimize ‘Risk – Return’ and diversify their portfolio. This (strongly interactive) presentation by CEO and Actuary Jos Berkemeijer, supports the power of Gold as the best asset class to optimize ‘Risk – Return’ in a given portfolio.

Just widen your knowledge about monetary gold by examining  the next  presentation given on June 19 2012 as a 'Johan de Witt Lecture' before 60 in gold interested actuaries of the Dutch Actuarial Association (Actuarieel Genootschap, AG), the professional association of actuaries and actuarial specialists in the Netherlands.

With the help of a button (""ACTuary NOW" ), Jos Berkemeijer calls for action by actuaries on several main issues . 

Gold as InvestmentGold as Investment