Risk management lessons from Philippe Jorion

One cannot skip Philippe Jorion, if he has taken a course in finance/MBA in finance. Atleast that seems to be the case in Indian schools. The moment your professor teaches about risk and moves to Value at Risk, he/she would most likely ask you to read Jorion’s famed book on VAR.

In his new paper cum speech, he suggests lessons for risk management from the crisis. He first reviews risk management systems in firms and points to differences between position based risk management system and returns based risk management system. Former is superior as is forward looking and gives more ideas but is more expensive. Opposite reasons apply for returns bases risk management systems.

He then classifies risks based on Donald Rumsfeld classification – known knowns, known unknowns and unknown unknowns. He puts risks in this crisis in erach of these categories.

  • Known unknowns- model risk, liquidity risk etc which were known but ignored by risk managers
  • Unknown unknowns- regulatory and structural changes in capital markets (shadow banks etc), contagion risks etc

Finally the lessons.

Lessons for risk managers are:

  • Risk management system should be driven by people

Lessons for Regulators are:

  • Do Stress Scenarios Tests and Reverse Stress Tests
  • Improve corp governannce and oversight

In the end he says:

 Overall, this crisis has reinforced the importance of risk management.

Well, that is true as nothing like risk management was actually happening.

But what struck me more is this reinforcement for risk management. No matter what economics expert you read right now- fiscal policy, monetary policy (inflation expectations, central banks communications, inflation targeting framework etc), demographics, corporate governance etc etc. The message you get is the same – that this crisis has reinforced the importance of fiscal policy, monetary policy (inflation expectations, central banks communications, inflation targeting framework etc), demographics, corporate governance etc etc.

Why don’t we get the same lesson for financial regulation? Most would say financial regualtion has failed in this crisis but don’t say we need to redo it. Infact most are worried that regulation would stifle financial innovation, would lead to worse outcomes and so on. Why is financial resulation seen as necessarily bad when we live in a world which is highly regulated?

 

3 Responses to “Risk management lessons from Philippe Jorion”

  1. Risk management lessons from Philippe Jorion « Mostly Economics | Management Business Wisdom Says:

    […] Read this article: Risk management lessons from Philippe Jorion « Mostly Economics […]

  2. Examining Strategic Risk – 'Strategic' Risk or 'Strategic Risk … | Management Business Wisdom Says:

    […] Risk management lessons from Philippe Jorion « Mostly Economics […]

  3. Microfinance helps or not? « Mostly Economics Says:

    […] I don’t know why financial regulation is always seen in this light. Why can’t financial regulation lead to better results? There […]

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