MarketRisk
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Risk

Risk is the possibility of something bad happening, comprising a level of uncertainty about the effects and implications of an activity, particularly negative and undesirable consequences.

Definition
The Oxford English Dictionary (OED) cites the earliest use of the word in English (in the spelling of risque from its French original, 'risque') as of 1621, and the spelling as risk from 1655. While including several other definitions, the OED 3rd edition defines risk as "(Exposure to) the possibility of loss, injury, or other adverse or unwelcome circumstance; a chance or situation involving such a possibility". The Cambridge Advanced Learner's Dictionary defines risk as "the possibility of something bad happening". The International Organization for Standardization (ISO) 31073 defines risk as:effect of uncertainty on objectives Note 1: An effect is a deviation from the expected. It can be positive, negative or both, and can address, create or result in opportunities and threats. Note 2: Objectives can have different aspects and categories, and can be applied at different levels. Note 3: Risk is usually expressed in terms of risk sources, potential events, their consequences and their likelihood. Other general definitions include: • "Source of harm" ::The earliest use of the word "risk" was as a synonym for the much older word "hazard", meaning a potential source of harm. This definition comes from Blount's "Glossographia" (1661) and was the main definition in the OED 1st (1914) and 2nd (1989) editions. Modern equivalents refer to "unwanted events" or "something bad that might happen". With slight rewording it became the definition in ISO Guide 73. to encourage innovation to improve public services. It allowed "risk" to describe either "positive opportunity or negative threat of actions and events". • "Potential returns from an event ['a thing that happens or takes place'], where the returns are any changes, effects, consequences, and so on, of the event" ::This definition from Newsome (2014) expands the neutrality of 'risk' akin to the UK Cabinet Office (2002) and Knight (1921). • "Human interaction with uncertainty" ::This definition comes from Cline (2015) in the context of adventure education. Versus uncertainty In his seminal 1921 work Risk, Uncertainty, and Profit, Frank Knight established the distinction between risk and uncertainty. Thus, Knightian uncertainty is immeasurable, not possible to calculate, while in the Knightian sense risk is measurable. By field Mathematical Triplets Risk is often considered to be a set of triplets An updated version recommends the following general description of risk: • Individual risk - the frequency of a given level of harm to an individual. It often refers to the expected annual probability of death, and is then comparable to the mortality rate. • Group (or societal risk) – the relationship between the frequency and the number of people suffering harm. • Frequencies of property damage or total loss. • Frequencies of environmental damage such as oil spills. == Financial risk ==
Financial risk
In finance, an elementary measure of risk for financial asset prices is with volatility, the degree of variation of a trading price over time, usually measured by the standard deviation of logarithmic returns. Portfolio theory Modern portfolio theory measures the riskiness of a portfolio using the variance (or standard deviation) of the portfolio. If we denote return by R(w) of a portfolio with weight vector w = (w_1,\dots,w_n)' then the risk, as measured by variance of the portfolio is given by : \text{Risk}=\mathrm{Var}(R(w)) = \sum_{i=1,j=1}^n w_j w_j\mathrm{Cov}(R_i,R_j) where R_i denotes the return of asset i=1,\dots,n . Modern portfolio theory tells us an optimal combination of weights creates an optimal portfolio - known as the tangency portfolio - that still has undiversifiable risk. The model implies this 'systematic' source of risk should be the only factor considered, as all other sources of risk can be diversified away. An extension of this is the Capital asset pricing model (CAPM), where this optimal portfolio becomes known as the market portfolio. The beta coefficient measures the sensitivity of an individual asset to overall market changes, and is defined as the linear projection coefficient of asset i=1,\dots,n returns on the returns of a market portfolio, \beta_i = \frac{\mathrm{Cov}(R_i,R_{mkt})}{\mathrm{Var}(R_i)} In a CAPM world, \beta_i can be interpreted as the contribution of systemic risk to the risk of asset i. Risk-neutral measure In mathematical finance, a risk-neutral measure is a probability measure such that each share price is exactly equal to the discounted expectation of the share price under the measure. This is heavily used in the pricing of financial derivatives due to the fundamental theorem of asset pricing. Let S be a d-dimensional market representing the price processes of the risky assets, B the risk-free bond and (\Omega,\mathcal{F},P)the underlying probability space. Then a measure Q is a risk-neutral measure if • Q\approx P, i.e., Q is equivalent to P, • the processes \left( \frac{S^i_t}{B_t} \right)_t are (local) martingales w.r.t. Q \forall \, i=1,\dots,d. Mandelbrot's mild and wild theory Benoit Mandelbrot distinguished between "mild" and "wild" risk and argued that risk assessment and analysis must be fundamentally different for the two types of risk. Mild risk follows normal or near-normal probability distributions, is subject to regression to the mean and the law of large numbers, and is therefore relatively predictable. Wild risk follows fat-tailed distributions, e.g., Pareto or power-law distributions, is subject to regression to the tail (infinite mean or variance, rendering the law of large numbers invalid or ineffective), and is therefore difficult or impossible to predict. A common error in risk assessment and analysis is to underestimate the wildness of risk, assuming risk to be mild when in fact it is wild, which must be avoided if risk assessment and analysis are to be valid and reliable, according to Mandelbrot. Estimation • Proxy or analogue data from other contexts, presumed to be similar in some aspects of risk. • Theoretical models, such as Monte Carlo simulation and Quantitative risk assessment software. • Logical models, such as Bayesian networks, fault tree analysis and event tree analysis • Expert judgement, such as absolute probability judgement or the Delphi method. ==Management==
Management
Risk management is the set of actions that organisations take to avoid and mitigate downside risks, innovation, the environment, safety, scientific evidence, culture, politics, and law. Assessment Risk assessment is a systematic approach to recognising and characterising risks, and evaluating their significance, in order to support decisions about how to manage them. ISO 31000 defines it in terms of its components as "the overall process of risk identification, risk analysis and risk evaluation": • The ISO defines risk analysis as "the process to comprehend the nature of risk and to determine the level of risk". For example, the tolerability of risk framework, developed by the UK Health and Safety Executive, divides risks into three bands: • Unacceptable risks – only permitted in exceptional circumstances. • Tolerable risks – to be kept as low as reasonably practicable (ALARP), taking into account the costs and benefits of further risk reduction. • Broadly acceptable risks – not normally requiring further reduction. Attitude, appetite and tolerance The terms risk appetite, attitude, and tolerance are often used similarly to describe an organisation's or individual's attitude towards risk-taking. One's attitude may be described as risk-averse, risk-neutral, or risk-seeking. Mitigation Risk transformation describes the process of not only mitigating risks but also employing risk factors into advantages. • Risk transfer is the shifting of risks from one party to another, typically an insurer. ==Psychology of risk==
Psychology of risk
Risk perception Risk perception is the subjective judgement that people make about the characteristics and severity of a risk. At its most basic, the perception of risk is an intuitive form of risk analysis. Adults have an intuitive understanding of risk, which may not be exclusive to humans. Many ancient societies believed in divinely determined fates, and attempts to influence the gods can be seen as early forms of risk management. Early uses of the word 'risk' coincided with an erosion of belief in divinely ordained fate. Notwithstanding, intuitive perceptions of risk are often inaccurate owing to reliance on psychological heuristics, which are subject to systematic cognitive biases. In particular, the accuracy of risk perception can be adversely affected by the affect heuristic, which relies on emotion to make decisions. The availability heuristic is the process of judging the probability of an event by the ease with which instances come to mind. In general, rare but dramatic causes of death are over-estimated while common unspectacular causes are under-estimated; an "availability cascade" is a self-reinforcing cycle in which public concern about relatively minor events is amplified by media coverage until the issue becomes politically important. Despite the difficulty of thinking statistically, people are typically subject to the overconfidence effect in their judgements, tending to overestimate their understanding of the world and underestimate the role of chance, with even experts subject to this effect. Other biases that affect the perception of risk include ambiguity aversion. Paul Slovic's "psychometric paradigm" assumes that risk is subjectively defined by individuals, influenced by factors such as lack of control, catastrophic potential, and severity of consequences, such that risk perception can be psychometrically measured by surveys. Slovic argues that intuitive emotional reactions are the predominant method by which humans evaluate risk, and that a purely statistical approach to disasters lacks emotion and thus fails to convey the true meaning of disasters and fails to motivate proper action to prevent them. This theory has received support from retrospective studies and evolutionary psychology. Hazards with high perceived risk are therefore, in general, seen as less acceptable and more in need of reduction. Cultural theory of risk views risk perception as a collective phenomenon by which different cultures select some risks for attention and ignore others, with the aim of maintaining their particular way of life. Hence risk perception varies according to the preoccupations of the culture. The theory outlines two categories, the degree of binding to social groups, the degree of social regulation. Cultural theory can be used to explain why it can be difficult for people with different world-views to agree about whether a hazard is acceptable, and why risk assessments may be more persuasive for some people than others. However, there is little quantitative evidence that shows cultural biases are strongly predictive of risk perception. Decision theory In decision theory, regret (and anticipation of regret) can play a significant part in decision-making, distinct from risk aversion. Framing is also a fundamental problem with all forms of risk assessment. In particular, because of bounded rationality, the risk of extreme events is discounted because the probability is too low to evaluate intuitively. As an example, one of the leading causes of death is road accidents caused by drunk driving – partly because any given driver frames the problem by largely or totally ignoring the risk of a serious or fatal accident. The right prefrontal cortex has been shown to take a more global perspective, while greater left prefrontal activity relates to local or focal processing. Reference class forecasting is a forecasting method by which biases associated with risks can be mitigated. Risk taking Psychologists have run randomised experiments with a treatment and control group to ascertain the effect of different psychological factors that may be associated with risk taking, finding that positive and negative feedback about past risk taking can affect future risk taking. For example, one experiment showed that belief in competence correlated with risk-taking behavior. Risk compensation is a theory that suggests that people typically adjust their behavior in response to the perceived level of risk, becoming more careful where they sense greater risk and less careful if they feel more protected. People also show risk aversion, such that they reject fair risky offers because of the perception of loss. Further, intuitive responses have been found to be less risk-averse than subsequent reflective response. Sex differences ==Philosophy of risk==
Philosophy of risk
Peter L. Bernstein (2012) showed that people used risk estimates before statistics and probability calculations were developed. Instead of relying on numbers, people used narratives and letters. Captains and merchants shared voyage stories at coffeehouses, comparing notes about hazards on new routes and seasonal patterns. Through a web of correspondents, letters became increasingly important as people could update their beliefs about weather, wars, or piracy over long distances. These qualitative data helped investors and underwriters judge how dicey a proposed voyage felt. This kind of evidence has led philosophers to think there is more to (objective) risk than the likelihood of an undesirable outcome. Ebert et al. (2020) suggest distinguishing risk monists from risk pluralists: risk monists argue that there is just one correct way to understand risk. Tversky and Kahneman can be considered monists in this sense; probability judgments that diverged from the probability calculus were deemed wrong or biased. By contrast, pluralists claim that there are different, valid notions of risk. On this view, people who lived before statistics were developed may have been doing something legitimate when they estimated risks—even if those estimates conflict with a statistical notion. Without statistics, what else could they have done? According to the modal account of risk, a situation is risky when nearby possible worlds—differing only slightly from the actual one—contain serious harm. Risk tracks the closeness of such bad outcomes rather than their probability; hence a low-chance disaster may still count as high risk if only a small change would have led to it. On the normic account of risk, a situation is risky when the bad outcome would be normal or unsurprising. ==Society and culture==
Society and culture
Risk and autonomy The experience of many people who rely on human services for support is that 'risk' is often used as a reason to prevent them from gaining further independence or fully accessing the community, and that these services are often unnecessarily risk averse. "People's autonomy used to be compromised by institution walls, now it's too often our risk management practices", according to John O'Brien. Michael Fischer and Ewan Ferlie (2013) find that contradictions between formal risk controls and the role of subjective factors in human services (such as the role of emotions and ideology) can undermine service values, so producing tensions and even intractable and 'heated' conflict. Risk society Anthony Giddens and Ulrich Beck argued that whilst humans have always been subjected to a level of risk – such as natural disasters – these have usually been perceived as produced by non-human forces. Modern societies, however, are exposed to risks such as pollution, that are the result of the modernization process itself. Giddens defines these two types of risks as external risks and manufactured risks. The term Risk society was coined in the 1980s and its popularity during the 1990s was both as a consequence of its links to trends in thinking about wider modernity, and also to its links to popular discourse, in particular the growing environmental concerns during the period. == See also ==
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