PART 1 - The concept of risk and a comparison between risk management and risk taking.
https://www.sscsrl.com/iso-31000-risk-management/
What is risk?
Potential variability of returns around an expected return (also called the mean), if we have a normal distribution, the mean is precisely in the middle, so the potential variability of returns refers to how it moves around the mean.
Financial risk can be managed and mitigated.
There is no return without risk.
Risk managers pride themselves in their ability to price risks and provide adequate compensation for the risk taken in business activities.
Example: to generate a return for shareholders, lenders such as JPMorgan Chase & Co. are faced with constant credit risk – borrowers / mortgagors by default on agreed upon payments.
RISK – The variability that can be quantified in terms of probabilities.
UNCERTAINTY – The variability that cannot be quantified at all.
Sports example: Basketball
Let's focus on LeBron, on his shooting skills. We can observe his foul shooting performance during the course of a season, count for a make and count for a miss and let's just suppose that LeBron is shooting foul shots at about 85%. So, what we can say is that if LeBron is going into the playoffs we can make an inference that says that LeBron has 85% of probability to shoot during the course of the playoffs.
That makes perfect sense so let's define risk as the variability of LeBron’s performance in the playoffs.
Now let's look at the mechanics of a foul shot. Imagine LeBron has the ball and he stands there, dribbles and finally shoots. We could say something like: you know he has an 85% chance of making any individual foul shot, so that's basically the risk but what about uncertainty?
Let's suppose that LeBron is dribbling and dribbling and right when he gets the ball up and starts his motion, everybody gets up, and there is no way to stop him, the lights in the arena turn off and LeBron continues and scores, that's uncertainty, the variability that cannot be quantified.
Thus, there is risk because the outcome, whether good or bad, is seldom predictable with complete certainty. There is risk inherent in nearly everything we do.
Risk is an integral part of the business or investment process.
Proper identification and measurement of risk, and keeping risks aligned with the goals of the enterprise, are key factors in managing businesses and investments.
Risk: uncertainty regarding future:
Not necessarily the size of the loss (predictable).
Variability of the loss or an unanticipated loss.
Risk management: how firms actively select the type and level of risk that it is appropriate for them to assume:
Expected vs unexpected loss.
Risk taking: active assumption of incremental risk in order to generate incremental gains.
Remember: The role of the risk manager is not to try to read a crystal ball, but to uncover the sources of risk and make them visible to key decision makers and stakeholders in terms of probability.
Information was gathered from:
Analystprep and GARP - Foundations of risk management content
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