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The concept of `risk' has undergone a drastic change. Today the trend and rightly so, is towards enterprise wide risk management. Companies are increasingly becoming aware that risks from various corners and various factors have to be factored into their strategic decision-making. The author discusses ERM vis-à-vis the traditional approaches to risk management along with its relevance in the context of the economic slowdown.
Enterprise
Risk Management (ERM) is a holistic approach to risk
management, the essence of which is to look at risks
as they affect the firm as a whole: we look at the
firm's overall exposure to risks and try to do so
taking account of how those risk factors interact with
each other.
The
ERM approach to risk management has a number of
advantages over what might be described as the
traditional approach to risk management set out in
standard textbooks. The essence of the textbook
approach is to hedge each individual risk factor on
its own, without taking account of the overall
portfolio risk exposure or the presence of natural
hedges within the portfolio. It therefore implicitly
presumes that we are dealing with a series of
independent risk factors _ and one problem, of course,
is that this independence assumption is usually
inappropriate. But even where risks are independent,
the traditional approach fails to allow for the
diversification of risks and requires that we hedge
each risk factor separately. If there are n risk
factors we wish to hedge, we do so by taking out n
separate hedge positions, rather than one hedge
against the portfolio as a whole. |
