This book is a series of papers arising from discussions between academics and practitioners over a period of time. It attempts to bring together academic thought on the various issues arising in relation to identification and management of risks. It has in the main achieved this, and the papers are a great collection of topical and relevant papers. The volume would make an excellent set of reading for advanced students in risk management.
The first chapter by the authors considers the conceptual framework for identifying risks as KuU, and shows how the other papers in the book contribute to a cohesive analysis of these risks and their management. For those interested in a summary of the book, they need go no further than this. In many ways it is an easier read than some of the later papers, where it is easy to get lost in the detail.
The papers begin with a reasonably straight forward description of the various definitions of risk, which could easily have been omitted or dealt with more quickly in a book of this standard. The second paper deals with the issue of extreme events and the shortcomings of the traditional Gaussian approach traditionally used in financial risk analysis. It introduces a new terminology for extreme events, perhaps intended to stop analysts thinking in Gaussian space, a worthwhile objective in this context.
The paper concerned with the term structure of risk introduces a concept that is explained intuitively, and demonstrates that optimal results are affected by the planning horizon selected. This paper is logically followed by the analysis of a process adopted at a hedge fund of funds manager to determine likely downside risk, and is essentially a coherent model based on a combination of ‘normal’ markets and particular types of crises, and while this must introduce a significant amount of ‘educated’ guesswork as to the crises that might occur, it has the advantage, as pointed out by the authors of the paper, that it brings a discipline to the process which is very different to the historically driven VaR approach.
The ranking of bank risks by considering the information known about them, and the detail available to a bank to measure the risk, and the inferred solvency ratio is a ‘must read’ for those interested in financial institutional regulation, and it provides some interesting views on the value of the Basel II framework based on the analysis.
The paper purporting to deal with real estate is much more powerful than just a statistical work, as it delves into the transition from one state of KuU to another, and considers the likely evolutionary path that might occur. It is a very worthwhile paper for the student interested in the non-stationarity of the risk states, and the likelihood of progressing from one state to the other.
For those interested in choice under uncertainty, a paper discusses this with an excellent summary of the thinking relating to this issue and further considers the issue from both individual and corporate perspectives.
Insurance is a common method of mitigating risk, and it is suggested the role of the broker is to increase market efficiency as the broker brings greater knowledge of a risk than the insurer might otherwise gain. In a natural progression, a paper then discusses the issues relating to the demand for and supply of catastrophe insurance, and addresses the need for some insurances to be compulsory, with government involvement.
The book then moves more to corporate issues, and a paper discusses the consequences of investors and management having different views on the KuU risks facing the enterprise, and coupled with greater intensity in the capital markets, the value of enterprises can move rapidly. This raises the question of how to suitably incentivise management to manage risks appropriately, but the papers dealing with these issues are relatively short.
