One problem with risk management is that it often lacks historical perspective. The models produce very precise probabilities of failure, usually reassuringly small, but the model and its calibration don’t really mean anything.
In the last century and bit we have had:
- Two world wars,
- Numerous other wars,
- Four global banking crises,
- A great depression,
- Many other recessions
- Oil price shocks,
- Numerous real estate and stock market bubbles,
- Many advanced economies basically wiped out by war (Germany has been ruined at least three times in the last hundred years despite being one of the richest economies in the world)
Each of these events had devastating financial consequences, but I do not see risk management reports considering these sorts of events. Often the mathematical models gave very low probabilities of ruin, say one in two hundred years. However, if we examine the actual history of the last two hundred years, would the company’s risk settings have survived the 1890’s banking crash, two world wars, the Great Depression, the 1970’s oil shock and inflation or the Japanese lost decades?
Directors and others involved in the risk management process should ask these questions?
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