Philosophies of risk management, briefly

November 18, 2009 in Finance,Risk

My last post made me think of a common question in risk management: "what is risk?"

A lot of time is spent deciding the various metrics, exposures, values, sensitivities, etc. that are considered "risks." In the previous post, a simple change of perspective - is risk defined by dollars invested or shares controlled? - resulted in a dramatically different investment decision (granted, it was for a hypothetical insider trade... so it was definitely more illustrative than practical).

In the investment equation, the very definition of risk is a variable, not a constant.

This is probably much more interesting to talk about than write about, given the open-endedness of the question, but I would like to highlight how critical that question is. Before risks can be managed, they must be measured; and before they are measured, they must be identified. It's very easy, particularly in a time when we are inundated by numbers and statistics, to look for a catch-all metric, or overlook risks that critical thinking would expose. Risk is rarely obvious.

Readers will know I am hardly espousing any sort of dive into complicated models or quantitative nonsense, merely an appeal to reason: every investment decision carries a unique set of risks which need to be identified and defined - from dollars invested, to sensitivities, to position in a larger portfolio, to leverage, and so on. More than merely identifying them, they should be understood - even VaR has itsĀ use, remember.

It wouldn't be right to end this without a HHG2G quote which is almost, but not quite, entirely unrelated. Let's just say it's about things we take for granted:

Time is an illusion. Lunchtime doubly so.

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