Risk forms an integral part of any financial decision as there always exists an element of uncertainty. Risk management should focus on identifying the potential unanticipated events and its possible impact on financial performance of the organization. Instead of placing each risk in a different category, the new mantra to be followed is a holistic approach towards risk management called the Enterprise Risk Management. First of all the organizations should set up appropriate policies, systems and procedures in place and identify the various types of risks they face.
Risk management is present in all aspects of life. it is about the everyday trade-off between expected rewards on a potential danger. We, in the business world, often associate risk with some variability in financial outcomes. However, the notion of risk is much larger. It is universal, in the sense that it refers to human behavior in the decision-making process. Risk management is an attempt to identify, to measure, to monitor and to manage uncertainty.
The potential outcomes and their probability of occurrence are the two necessary parameters to evaluate risky situations, whether this evaluation is made consciously or unconsciously.The recognition of the potential outcomes is the first task of risk management, to identify and assess the probability of occurrence is the second one. measuring, monitoring and managing uncertainty are functions of the decision-maker's values, risk-taking behavior and ability to follow the evolution of the situation.
As anywhere else, risk is a component of financial decisions. Financial decisions being an integral part of human activity, risk management can be traced far back to ancient times. In their framework for risk management, Froot, Scharfstein and Stein (1994) give an interesting example from the Old Testament. It tells the story of an Egyptian Pharaoh who dreamed that seven healthy cattle were devoured by seven sick cattle and that seven sick ears of corn devoured seven healthy ears of corn.
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