Risk ManagementUniversity of Economics, Kraków, 2012

Tomasz Aleksandrowicz

What is risk ?

risk definition

• the possibility of suffering harm or loss; danger.• a factor, thing, element, or course involving uncertain danger;

a hazard• combination of the probability of an event and its

consequences (risk management standard)• probability that an actual return on an investment will be

lower than the expected return (finance)• (Exposure to) the possibility of loss, injury, or other adverse or

unwelcome circumstance; a chance or situation involving such a possibility (Oxford English Dictionary, 1655)

risk definition

• The first symbol is the symbol for “danger”, while the second is the symbol for “opportunity”, making risk a mix of danger and opportunity

Risk in general

• possibility of loss or injury– something could be lost / injuried by accident or misfortune

• potential for a negative impact– something could go wrong

• likelihood of an undesirable event– some event may cause negative influence

upside of risk

• risk provides the basis for opportunity• not only negative or downside:– risk of not meeting our goals– risk of missing an opportunity– risk of not recognising that something good is happening

• results may be better or worse than expected• the upside of risk is the reason for accepting

exposures and opportunities

risk/return trade-off

• the balance between the desire for the lowest possible risk and the highest possible return

• no risk / low risk = low return• the higher risk means the possibility of higher returns• Preferred trade-off depends on risk tolerance / risk

appetite

Risk vs uncertainty

• risk - variability that can be quantified in terms of probabilities

• uncertainty - variability that cannot be quantified at all

In effect there is need for clarity of degree to which the results depend on statistically measurable risk and to which depend on factors that are entirely uncertain at the time of the analysis.

Different types of riskCase-study

Main risk categories

strategic / business risk•environment•political / regulatory•competitors•customers•reputation

financial risk•market•credit•liquidity

operational risk•people•process•technology•natural events

Financial risk in detailed look

Risk sources – where risk comes from

• organization environment events, changes or trends• organization’s exposure to changes in market• actions and transactions of the organization• avoiding necessary actions • failures of the organization, particularly people,

processes, and systems• hazard or natural events

History of risk

History of risk

• games of chance and hazard has been popular since accient times (as far as Egypt 3500 BC)

• until the Renaissance that no “scientific” or statistical basis for gambling was presented – arabic numerc system 0-9 digits between X-XII,– treated as secret knowledge)

• In middle ages in Europe word ‘risicum’ used in context of sea trade

• English word ‘risk’ comes from old French word risqué -“danger, in which there is an element of chance”

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History of risk (II)

• In XVI Girolamo Cardano (physician, gambler, and mathematician) wrote a book titled, Liber de Ludo Aleae (“Book on Games of Chance”) - first study of probability in games of that kind

• Galileo Sopra le Scoperte dei Dadi (“On Playing Dice”) (1630)• In XVII basics of probability theory by Pierre de Fermat, Blaise

Pascal and Christiaan Huygens• In XVIII basics of statistics theory developed by Pierre-Simon

Laplace, Joseph Lagrange or Daniel Bernoulli• In XIX moder statistics thoery introduced (Carl Gauss and

many others)

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History of risk (III)• In XX modern probability theory by Andrey Nikolaevich

Kolmogorov• In XX risk introduced into finance as first rating agencies

emerged in US (i.e. Moody’s at 1906)• Frank Knight book “Risk, Uncertainty and Profit” (1921)• Scenario analysis matured during cold war• Risk management as discipline became popular in ’60 of XX –

starting with hazard risk management• Scientific approach to risk in finance introduced in ‘60 (with

CAPM model) and become popular in ‘80 (derivatives, ERM)• Computers revolutionized risk studies in late ‘90s

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