Current Issues in Risk Management           Stewart Hodges         Cass Business School    Fourth Annual Conference Of The...
Current Issues in Risk ManagementStructure of the Presentation:  1.    What are we good at?  2.    Where may we see improv...
What Are We Good At?  1. Modelling short term market risks under “normal”     conditions.          includes time varying ...
What Are We Good At?  2.    Modelling a wide variety of contingent claims           Under increasingly complex assumption...
Where May We See Improvements?  1. Modelling and managing counterparty risk, including     two-way risk.  2. Quantifying l...
Where May We See Improvements?  1. Modelling and managing counterparty risk, including     two-way risk.  2. Quantifying l...
Where May We See Improvements?  3.    Coping with other changes in the environment,e.g.           new instruments, e.g. C...
What Are We Bad At?  1. Modelling extreme risks:         Stress testing,           (what scenarios?)         Use of copu...
Where Are We Most Vulnerable?  1.    The world economy, e.g.           Chinese surpluses / trade wars           Stagflat...
Where Are We Most Vulnerable?  3.    Other unsolved problems of Basel III, e.g.:            What to do about “too big to ...
Some Open Questions  1. Do we have too much regulation and micro-     management of risk in place of sensible incentives? ...
Some Open Questions  4. Lord Adair Turner asks key questions about:       the balance between debt and equity contracts  ...
Postscript  100 years ago Lilian Bland flew an aeroplane she had  designed and built herself.  She may have understood ris...
References   Acharya, V and M Richardson (Eds) Restoring Financial Stability: How to Repair a    Failed System, Wiley 200...
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Current Issues in Risk Mangement

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Current Issues in Risk Management
Presenter: Stewart Hodges
Cass Business School
Fourth Annual Conference of the Cass-Capco Institute Paper Series on Risk
April 14, 2011

Published in: Economy & Finance, Business
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Current Issues in Risk Mangement

  1. 1. Current Issues in Risk Management Stewart Hodges Cass Business School Fourth Annual Conference Of TheCass-Capco Institute Paper Series On Risk Cass Business School, 14th April 2011
  2. 2. Current Issues in Risk ManagementStructure of the Presentation: 1. What are we good at? 2. Where may we see improvements? 3. What are we bad at? 4. Where are we most vulnerable? 5. Some open questions.Stewart Hodges Issues in Risk Management: 2
  3. 3. What Are We Good At? 1. Modelling short term market risks under “normal” conditions.  includes time varying volatilities and covariances. 2.00% VaR Limits and Returns 1.50% 1.00% 0.50% 0.00% Dec 2009 Mar 2010 Jun 2010 Sep 2010 Dec 2010 -0.50% -1.00% -1.50% -2.00%Stewart Hodges Issues in Risk Management: 3
  4. 4. What Are We Good At? 2. Modelling a wide variety of contingent claims  Under increasingly complex assumptions,  Aggregation across disparate models,  Valuation is understood better than hedging – which is understood better than residual risk. 3. Return attribution  important for understanding the nature of deficiencies in existing systems through the way risks are mapped.  often underused.Stewart Hodges Issues in Risk Management: 4
  5. 5. Where May We See Improvements? 1. Modelling and managing counterparty risk, including two-way risk. 2. Quantifying liquidity and transactions costs.  Optimising execution,  managing liquidity sources.Stewart Hodges Issues in Risk Management: 5
  6. 6. Where May We See Improvements? 1. Modelling and managing counterparty risk, including two-way risk. 2. Quantifying liquidity and transactions costs.  Optimising execution,  managing liquidity sources. Caveats: ..but liquidity behaves like a “will-o’-the-wisp”, and there is also a tension between exposures to counterparty risk and to cash flow risk.Stewart Hodges Issues in Risk Management: 5
  7. 7. Where May We See Improvements? 3. Coping with other changes in the environment,e.g.  new instruments, e.g. Cocos, inflation linked SPs,  multiple curve term structure models 4. Visualisation of risk positions.  Most of our risk management charts haven’t changed much for years,  Visual presentation is important and untapped resources are available.Stewart Hodges Issues in Risk Management: 6
  8. 8. What Are We Bad At? 1. Modelling extreme risks:  Stress testing, (what scenarios?)  Use of copulas (empirical issues). 2. Understanding the financial system as a whole:  The nature of feedback effects,  Measurement of (contribution to) systemic risk. 3. Understanding the full implications of new products and new technologies.Stewart Hodges Issues in Risk Management: 7
  9. 9. Where Are We Most Vulnerable? 1. The world economy, e.g.  Chinese surpluses / trade wars  Stagflation / sovereign defaults 2. Market dislocations:  Bubbles and crashes,  Flash crash, volume of “piggy-back” electronic trading unconnected to fundamentals of prices,  Cyber terrorism / civil unrest etc.Stewart Hodges Issues in Risk Management: 8
  10. 10. Where Are We Most Vulnerable? 3. Other unsolved problems of Basel III, e.g.:  What to do about “too big to fail”, - including can firewalls work?  Making counter-cyclical provisions  How many CCPs should there be, and how many members should each have?  Scope of regulation 4. Our reaction to each crisis sows the seeds of the next one:  What sort of crisis is it most likely to be?  What would we like it to be?!Stewart Hodges Issues in Risk Management: 9
  11. 11. Some Open Questions 1. Do we have too much regulation and micro- management of risk in place of sensible incentives? Have institutions evolved to be over-adapted to their environment? 2. Can risk be managed successfully by following a check list? c.f. safety in aviation etc. 3. Are risk issues yet given sufficient weight at the top levels of organisations?Stewart Hodges Issues in Risk Management: 10
  12. 12. Some Open Questions 4. Lord Adair Turner asks key questions about:  the balance between debt and equity contracts in the economy and the financial system,  the aggregate extent of maturity transformation which the financial system performs, and  the economic functions which finance performs, including its social value. 5. What needs to be done to create a better alignment of interests?Stewart Hodges Issues in Risk Management: 11
  13. 13. Postscript 100 years ago Lilian Bland flew an aeroplane she had designed and built herself. She may have understood risk management rather better than we do - she died in 1971 aged 92.Stewart Hodges Issues in Risk Management: 12
  14. 14. References  Acharya, V and M Richardson (Eds) Restoring Financial Stability: How to Repair a Failed System, Wiley 2009  Berd, A (Ed), Lessons from the Financial Crisis, Risk Books, 2010.  BIS, Basel III: International framework for liquidity risk measurement, standards and monitoring, December 2010. From: www.bis.org/publ/bcbs188.pdf  BIS, “Basel III: A global regulatory framework for more resilient banks and banking systems”, December 2010. From: http://www.bis.org/publ/bcbs189.pdf  Demos: Lessons from the global financial crisis, Nov 2008, From: www.demos.co.uk/files/Apocalypse%20-%20%20web%202.pdf  Gatheral, J, “Optimal Order Execution”, WP 2010  Turner, A, ”Leverage, Maturity Transformation And Financial Stability: Challenges Beyond Basel III”, Speech presented at Cass Business School, 16th March 2011, Downloadable from: http://www.fsa.gov.uk/pubs/speeches/031611_at.pdfStewart Hodges Issues in Risk Management: 13

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