Finance School of Management Chapter 10: An Overview of Risk management Obiective Risk and financial Decision makin Conceptual Framework for Risk Management Efficient Allocation of Risk-Bearing uesTc
1 Finance School of Management Chapter 10: An Overview of Risk Management Objective • Risk and Financial Decision Making • Conceptual Framework for Risk Management • Efficient Allocation of Risk-Bearing
Finance School of Management Contents What is risk? Risk and economic decisions The risk management Process The Three dimensions of risk transfer Risk Transfer and Economic efficiency Institutions for Risk Management Portfolio Theory: Quantitative Analysis for Optimal Risk Management Probability Distributions of Returns Standard Deviation as a Measure of risk uesTc
2 Finance School of Management ❖ What is Risk? ❖ Risk and Economic Decisions ❖ The Risk Management Process ❖ The Three Dimensions of Risk Transfer ❖ Risk Transfer and Economic Efficiency ❖ Institutions for Risk Management ❖ Portfolio Theory: Quantitative Analysis for Optimal Risk Management ❖ Probability Distributions of Returns ❖ Standard Deviation as a Measure of Risk Contents
Finance School of Management Roles of risk management One of the three analytical"pillars to finance risk allocation(redistribution) uesTc
3 Finance School of Management Roles of Risk Management ❖ One of the three analytical “pillars” to finance ❖ Risk allocation (redistribution)
Finance School of Management Concept of risk Uncertainty that matters Illustration: Preparing foods for your party Gains& losses, upside” potential& downside” possibility uesTc
4 Finance School of Management Concept of Risk ❖ Uncertainty that matters ❖ Illustration: Preparing foods for your party ❖ Gains & losses, “upside” potential & “downside” possibility
Finance School of Management Risk Aversion A characteristic of an individuals preference in risk-taking situations Experiment Prefer lower risk given same expected value Decreasing marginal utility of income Rational behavior assumed to be risk-averse .o a measure of willingness to pay to reducing risk uesTc
5 Finance School of Management Risk Aversion ❖ A characteristic of an individual’s preference in risk-taking situations − Experiment ❖ Prefer lower risk given same expected value ❖ Decreasing marginal utility of income ❖ Rational behavior assumed to be risk-averse ❖ A measure of willingness to pay to reducing risk
Finance School of Management Risk management The process of formulating the benefit-cost trade- offs of risk reduction and deciding on the course of tion action to take The appropriateness of a risk-management decision should be judged in the light of the information available at the time the decision is made Skill and lucky in risk management uesTc
6 Finance School of Management Risk Management ❖ The process of formulating the benefit-cost tradeoffs of risk reduction and deciding on the course of action to take. − The appropriateness of a risk-management decision should be judged in the light of the information available at the time the decision is made. − Skill and lucky in risk management
Finance School of Management Risk exposure Particular types of risk one faces due to ones circumstances job, business, and pattern of consumption, etc Ⅲ ustrations the risk of a crop failure and the risk of a decline in the price for a farmer the risks of fire, theft, storm damage earthquake damage f or a house owner the currency risk for a person whose business involves imports or exports of goods uesTc
7 Finance School of Management Risk Exposure ❖ Particular types of risk one faces due to one’s circumstances (job, business, and pattern of consumption, etc.) ❖ Illustrations – the risk of a crop failure and the risk of a decline in the price for a farmer – the risks of fire, theft, storm damage, earthquake damage for a house owner – the currency risk for a person whose business involves imports or exports of goods
Finance School of Management Speculators and Hedgers Hedgers: taking positions to reduce their exposures Speculators: taking positions that increase their exposure to certain risks in the hope of increasing their wealth .o The riskiness of an asset or a transaction cannot be assessed in isolation or in abstract uesTc
8 Finance School of Management Speculators and Hedgers ❖ Hedgers: taking positions to reduce their exposures. ❖ Speculators: taking positions that increase their exposure to certain risks in the hope of increasing their wealth. ❖ The riskiness of an asset or a transaction cannot be assessed in isolation or in abstract
Finance School of Management Risks Facing Households Sickness, disability, and death Unemployment Consumer-durable asset risk .o liability risk Financial-asset risk uesTc
9 Finance School of Management Risks Facing Households ❖ Sickness, disability, and death ❖ Unemployment ❖ Consumer-durable asset risk ❖ Liability risk ❖ Financial-asset risk
Finance School of Management Risks Facing Firms Production risk and red risk Price risk of outputs Price risk of inputs uesTc 10
10 Finance School of Management Risks Facing Firms ❖ Production risk and R&D risk ❖ Price risk of outputs ❖ Price risk of inputs