Borge D. -The Book of Risk
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desirable risks, 69
detachment, 7, 38
diversification
benefits of, 116
impact of, 70–75, 81–82
value at risk (VaR), 114–115
emotion, impact on decisions, 194
emotional assets, 202, 204
emotional liabilities, 202, 204
equity risk, 122, 125, 131, 149–150, 162
euros, risk analysis, 162–183
exchange rate, 124, 164
expected rate, 155–157
expected returns, 114, 117–118
expected utility
fundamental strategies, 73, 75
highest, 31
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home insurance example, 214–215
implications of, 20–24, 31
life decisions, 198, 205, 214–215
maximizing, 45
expected value, 213–214
expert systems, 223
explicit preferences, 16–17
fact-finding analysis, 47–48, 189
fair value, 126–127
fatalist attitude, 7–8
fight or flight response, 188–189
financial assets, 201
financial institutions, risk management and, 225–226, 229
financial liabilities, 202
financial models, zealotry and, 96–97
financial planners, functions of, 216
financial risk management, development of, 114
financial risk managers, functions of, 66–67
financial risks
defined, 104, 106–119, 122
types of, 5, 104–105, 122
fixed rate loan, 140
foreign currency, 124
foreign exchange rate, see exchange rate
fundamental strategies
buying risks, 69–70
concentrating risks, 75–76
creating risks, 69
diversifying risks, 70–75
hedging, 76–77
insuring risks, 80–82
leveraging, 78–80
risk identification, 65–67
risk prevention, 68–69
risk quantification, 68
selling risks, 69–70
future volatility, 53, 55
global competition, impact of, 226, 234
government, risk management techniques, 231–232
Greenspan, Alan, 153
hedging, 76–77
highest expected utility, 31
hindsight, 81, 88–89
historical volatility, 53–54, 59
home insurance, 208–216
human nature, 86
idealists, 46
idealized decision-making, card game illustration, 13–21
identification of risks, 65–67
illogical decisions, 97
incentives, 146, 180–181
individuals, risk management techniques, 119–120, 232–233
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inertia, 92–93
inflation, 232
information gathering, 179
informed belief, 54
informed decisions, 218, 220
instinct
fight or flight response, 188–189
impact of, 187–189
marriage proposal example, 190–195
institutions, risk management and, 119–121
insurance policies, 81
home insurance example, 208–216
insuring risks, 80–82
intangible contingent claims, 141
intellectual assets, 201, 203
intellectual liabilities, 202–203
interest rates
euros and, 166–168
risk, 122–124, 130–131, 149–151
risk analysis and, 151–152
volatility and, 152–153
intrinsic value, 204
intuition, 115, 119, 171, 192
irrationality, 98–99
judgment, 48, 109
Kahneman, Daniel, 85–86
leadership, significance of, 178
left tail, 110
leveraging, 78–80, 158–162
liabilities, 141–144, 183. See also personal liabilities
LIBOR, 140
life decisions
gourmet/lean lifestyle example, 196–199
home insurance example, 208–216
instinct and, 188–189
marriage proposal example, 190–195
portfolio perspectives, 199–207
TPA example, 217–220
life span, 196
limited liability, 80
liquidity, 129–130, 226 risk, 122, 126–131, 148, 150, 162
logic, 47–48, 85, 115, 188, 192, 220
lottery tickets, 41
market conditions, impact of, 96–97, 129–130. See also Volatility
Markowitz, Harry, 114–115, 117–118, 131
marriage proposal example, 190–195
Marx, Karl, 121
mean, 109, 111–112
medical scientists, 47–48
meteorologists, 34, 67
modern risk management, 20, 50, 105, 224–225
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Morgan, J. P., 45
myopia, 54, 91–92
negative correlations, 58
Nelson, Admiral, 45
net loss, 161–162
net worth, implications of, 142–147, 155–157, 169–170, 172–174
normal distribution, 109–112
notes, bond investments compared with, 147–157
objectivity, 7–8
odds, in probability, 33, 40–41
operating risk, 122, 125–126, 131, 149–150, 163
optimism, 87–89
option contracts, 112–113, 140
outcomes, generally, 31, 87, 108–109. See also probability
overcompensation, 90
overconfidence, 86–87, 89
overoptimism, 93
overselling, 195
pattern seeking, 89–90
payoff, 31, 39
pension plans, 227–228
perfect hedge, 76–77
personal assets, types of, 201–203
personality volatility, 49, 51
personal liabilities, types of, 202–203
personal risk 202–203
pessimism, 97
physical assets, 201, 203
physical liabilities, 202–203
preferences
decision-making process and, 16–19, 23, 25
of institutions, 120
life decisions and, 210
neglect of, 42
rationality and, 98–99
risk aversion and, 39–40, 42
risk management philosophy and, 26–27
shareholder, 175
subjectivity of, 39
Prime Rate, 140
probability
assessment of, 33–34
coin game, 35–37
in decision-making, generally, 14–15, 22, 31
leverage and, 80
normal distribution, 109–112
urn game, 35–38
psychological obstacles
complacency, 93–95
hindsight, 88–89
inertia, 92–93
myopia, 54, 91–92
optimism, 87–89
overcompensation, 90
overconfidence, 86–87, 89
pattern seeking, 89–89
zealotry, 95–97
put options, 231
quantification of risk
correlation, 56–61, 68
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quantification of risk (cont.)
financial risk and, 106–107
fundamental strategy, 68
implications of, 50–51
volatility, 49–56, 68
rainfall, correlation illustration, 57–58
RAROC (Risk Adjusted Return on Capital), 178, 183
rational decisions, psychological obstacles, see psychological obstacles
rationality, 8, 85, 97–98
recession, impact of, 177
risk(s). See also fundamental strategies
aversion, 19, 38, 40, 42, 108, 211, 215
buying, 69–70
categorization of, 66–67
commodity, 122, 124, 131, 149–150, 162
concentrating, 75–76
creating, 69
credit, 122, 130–131, 148, 150, 162
currency, 122, 124, 130–131, 148, 150
desirable, 69
diversifying, see diversification
equity, 122, 125, 131, 149–150, 162
exposure, 5, 68, 178
financial, see financial risks
hedging, 76–77
identification of, 65–67
insuring, 80–82
interest rate, 122–124, 130–131, 149–151
judgment, 109
leveraging, 78–80, 158–162
liquidity, 122, 126–131, 148, 150, 162
management, see risk management
minimization, 229
operating, 122, 125–126, 131, 149–150, 163
prevention strategies, 68–69
quantification of, see quantification of risk
selling, 69–70
risk analysis, 54–55, 109
euros, 162–183
risk-averse investors, 114
risk capital, 107
risk management. See also strategic risk management
applications of, 5–6
basic ideas of, 4
control in, 130, 177–178
defensive motive, 229
financial institutions and, 225–226, 229
goal of, 69
government techniques of, 231–232
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idealist approach to, 12–28
importance of, 232–233
individuals, techniques of, 119–120, 232–233
institutions and, 119–121
models, corporate, 226, 229
modern, 20, 50, 105, 224–225
philosophy and preferences, 26–27
risk, meaning of, 9–11
risk analysis distinguished from, 54
uncertainty and, 7–9
risk management culture, 180–181
rogue traders, 120, 179
roulette, 34
Russell, Bertrand, 97
Sanford, Charlie, 178
Savage, John, 20–21
scientific method, 7–8
selling risks, 69–70
senior management
incentives for, 146, 180–181
role in risk management, 181
Smith, Adam, 97, 121
Social Security, 227
Soros, George, 153
spending power, 124
sports bets, hedge illustrations, 76–77
standard deviation, 109–110, 117–118
statistician, functions of, 32–33, 57
statistics, applications of, 54–55, 59
Steel, Duncan, 88
stock market crash of 1997, 113
stock portfolio
asset mix, 174
correlation and, 59–61
diversification of, 70–71, 114–116
leverage strategy, 78–80
options, 112–113, 140
stock selection, 115–116
value at risk (VaR), 113