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Electronic and Algorithmic Trading, Risk Management and GreenIT. Read our articles and case studies.
Risk Management is the top priority for many financial services companies. The reasons are obvious. What’s not obvious is what they should do about it. Our research has revealed that most companies are focused on standard best practices including: scenario analysis, MPT based analysis, Risk Adjusted Returns, VAR etc. Too many of them assume that this will protect from future adverse events.
Unfortunately, recent history suggests that this is a very poor assumption. Below are 10 things that your team should consider as they embark on a new Risk Management program.
1. Many firms that went under, are in trouble, or suffered massive loses were using sound risk management practices.
2. There is no way to reliably predict events like those in recent history.
3. The efficacy of most risk models are truly tested only after some bad event. Often times, they are not affirmed. Don’t assume that because you haven’t been hit, that your models, processes and practices are working.
4. Invest in different approaches. Simply consider what you had intended to do and focus on discovering alternatives.
5. It’s not enough to consider adverse movements, you must consider near-worst-case scenarios.
6. Near-Worst-Case Scenario Models must be different than other risk and trading models.
7. Consider Disaster Recovery Scenarios for risk management. This concept is often used in systems management and business continuity planning. It can also be applied to financial or market “disasters”. Start by assuming that a disaster has occurred —- now how do you claw your way out of it. Remember, some events cannot be expected or avoided, so having a plan to deal with it is as important as trying to avoid it.
8. As for liquidity… just because everyone is trading it, doesn’t mean it’s liquid. However, it does
mean that a bigger vacuum will be left behind when something bad happens.
9. Diversify your risk management team… and take inventory of what they are telling you to do. if it all sounds the same, it’s not diversified. Often, risk teams are too small and a lack diversity of ideas.
10. Continuously improve your risk platform, including systems, processes and people. All to often, companies engage in long-term risk infrastructure efforts who’s implementation becomes obsolete before they’re completed.
The main point is you should implement new methods and tackle the complexity of risk with a diverse set of approaches. Simply implementing solutions based on what’s available or conventional wisdom is not sufficient.
“If nothing changes, nothing changes”.
(photo via vlastula)
