Risk war games: Wrong input and process audits

Introduction

Risk management is understanding and controlling exposure to bad outcomes. Risk managers often focus on extreme events that may overwhelm a system. Scenarios simulate extreme events and expected price outcomes. In non-natural disasters, the worst outcomes often occur when the inputs and processes seem to operate normally, but wrong processes are in place. Wrong process risk is undermanaged.

Risk exposure occurs when a manager exposes cash or the balance sheet to a (return generating) system such as an equity, bond, business line or some other system with an expected net positive cash flow.  This exposure is to a system made up of inputs, processes and outputs.

Especially Interesting Excerpt

Wrong process risk is often more dangerous than extreme event risk. Wrong processes create the illusion of normally functioning systems with successful outputs (profits) in the short or medium term.  The false appearance of normal operational “profitable” behavior means that processes aren’t inspected or deeply questioned and challenged.  In finance, like businesses, the only axiom more dangerous than, “If it ain’t broke don’t fix it.”, is probably, “if it is making money, don’t question it.”  It is occasionally forgotten that humility and vigilance are often the price for excellence in finance.

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16. November 2010 by Miguel Barbosa
Categories: Curated Readings, Risk & Uncertainty | Leave a comment

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