Risk Management Wisdom

Identifying, quantifying and managing complexity is one of the least developed areas in financial riskmanagement
In the financial universe there are no isolated systems: personal, corporate and country risks interlinked in a correlation web
The web of financial contracts and interdependencies is complicated but finite. in due course it can be understood and tamed
Financial risk model complexity and quality are not necessarily correlated. But complexity is also in the eye of the beholder

Applying quantitative models to financial phenomena is subject to severe misspecification, whether intentional or unintentional
When there is no empirical basis to support risk assessment the fallback is polling expert opinion. Human experts will use analogy
Scenario analysis is a basic building block for a probabilistic approach to risk
Diversification versus model risk are the two key phenomena relevant for managing portfolio risks
In a crisis, all correlations go to one. Except this phenomenon concerns market expectations and prices and actual events might be less correlated
Some risks can be usefully decomposed into a probability of occurrence and a severity of occurrence. Others have a continuous range
Risk is about the deviation /uncertainty around expectation. A bad outcome expectation with little remaining uncertainty is not risky
Risk is not linear. Robust ratings need log-scale: 10%, 1%, 0.1% hence limited in number. Alphabet soup not a good risk metaphor
Credit risk analysis looks at the 1) ability and 2) willingness of an entity to fulfill its contracts. It gets messier very fast
All risk models built on past experience. some may contain an element of truth about the future

After the simplest binary, risk on / off choice, next step up in risk management complexity is the traffic light system: green, orange, red
First recorded incident of bank risk concentration: Florentine banks' Bardi and Peruzzi sovereign exposure to King Edward III
Regulation is supposed to prevent financial crises. the track record seems not good but we don't really know a world without it
Financial crises are recurring economic phenomena where prevailing contractual arrangements / designs get severely challenged
Risk insurance can remove risk but does create new risks (exposure to the insurance provider and other residual risks)
There is risk and there is the perception of risk. The two are only loosely correlated and perception is generally more volatile
One of the simplest and most effective forms of risk management is risk avoidance (also termed zero risk appetite)
Operational risks definitely scale with the size and complexity of the organization but the precise law is not easy to establish
There is no physical law to prevent even the deepest, most active, market to become illiquid
All forms of financial risk are subordinate to sovereign risk

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