Risk Management As A Crisis

1778 Words8 Pages
This essay will explore three areas of risk management which have been criticised in recent years due to their earlier neglect. Following the description of the problem and the current status of risk management research in each given area, a brief conclusion is provided. The conclusions in this essay aim to address the issues in risk management more generally by building on the status of risk management studies. Weakness 1: Reliance on Static Correlation Assumptions in Dynamic World It has been observed that correlations between asset prices through periods of market uncertainty differ markedly from those seen in quieter periods. Literature on the subject generally coincides in that such differences in correlations are a result of either…show more content…
Sandoval Junior et al provide a glimpse into the models currently being used to study complex systems whose correlation is unknown in an attempt to overcome some of the limitations addressed above. Random matrix theory is one of those approaches that were successfully tested. This approach contrast the values of a correlation matrix obtained from a real system to those obtained from a pure random matrix. More recently, random matrix theory with time lags has been used to compute time series correlations among world stock indices with success. However, these techniques require much more sophisticated risk management models, and may be beyond the means for large numbers of market participants. Others like Loisel have publicly argued against the increasing sophistication of correlation models, adding that better risk management standards do not mean replacing a simple model with a “Gaussian copula with a mixture of Student copulas.” Instead, Loisel argues the risk management professionals need to pay more attention to studying non-stationary risk processes and dynamic correlations with the aim of better understanding the sources of risk, rather than overcompensating with model complexity. Conclusion on Use of Common Sense Building on Loisel, perhaps the biggest shortcoming in risk management strategies is the overreliance on complex models
Open Document