Corporate risk management serves as the cornerstone for creating a robust reference framework that equips companies to adeptly navigate the complexities of risk and uncertainty inherent in their financial and economic activities. At its core, the risk management process is an integral component of strategic development, meticulously designed and planned at the highest echelon.
The board plays a pivotal role in defining the risk appetite of the company, laying the foundation for an integrated risk management approach. This approach encompasses the identification, assessment, and management of risks, as well as the evaluation, control, and monitoring of their interdependencies. In essence, the goal is to address not only the probability and frequency of events but also their consequences, often skewed towards the negative in the realm of pure risk.
Pure risk, a fusion of event probability and consequences, forms the backdrop against which companies strategize. Measurement of risk goes beyond the volatility of results, often necessitating consideration of higher moments in the distribution. Uncertainty, on the other hand, introduces a degree of imprecision, as the probability and consequences of uncertain events are often subjective or unknown. In such cases, a focus on precautionary measures becomes imperative to safeguard against uncertainty.
Involving opportunistic activities aimed at mitigating future risks that may yield positive or negative results. This strategic approach encompasses various activities such as diversification, risk hedging using derivatives and structured products, market insurance, self-insurance, and self-protection. The overarching objective is to maximize company or portfolio value by minimizing costs associated with risk.
Often insurable and not necessarily exogenous, particularly in the presence of moral hazard and known in the presence of adverse selection.
Involves variations in prices of commodities, exchange rates, and asset returns
Encompasses the probability of default, recovery rate, and exposure at default.
Arises from employee or management errors, fraud, IT system breakdown, and derivative mispricing.
Entails the risk of inadequate funds to meet short-term financial obligations without impacting prices, which may escalate into default risk.
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