The Future of Risk Management

Programme updated 16 September 2011. Conference material updated 23 September 2011.

 

Given the tremendous advances in financial risk measurement, why did risk management fail in large and complex financial institutions prior to the global financial crisis? Problems have been identified at least in 1) corporate governance as regards the position and true influence of risk management and in 2) risk measurement methodologies. Related to the first, compensation structures have a close connection with risk taking incentives and hence have a strong bearing on risk management. Methodological issues in turn are part of the larger question of what future emphases economic and financial modeling should take in the light of the crisis and the developments that led to it. The endogenous nature of risk will have to be taken more seriously in risk management. Better understanding and modeling of systemic risks have to be built. However, how much of systemic risks can be expected to be addressed by individual institutions and how much is left to institutions representing public interest is an important question. Overall, risk management may need to put more emphasis on economic theory dealing with market frictions and incompleteness. It should not only rely on financial engineering which is often based on the assumptions of perfect and complete markets with no problems of asymmetric information. Some of these aspects may be very difficult to translate into quantitatively reliable models. Therefore, risk management may have to be supplemented with a much stronger qualitative approach than has often been the case in the previous years.