Rethinking Risk Management
Rethinking risk management by René M. Stulz*
Revised, September 1996
*Bower Fellow, Harvard Business School; Reese Chair in Banking and Monetary Economics, The
Ohio State University; Research Associate, National Burea of Economic Research. I am grateful for u comments to Steve Figlewski, Andrew Karolyi, Robert Whaley, and participants at a seminar t a McKinsey, at the Annual Meetingof the International Association of Financial Engineers, and at the
French Finance Association.
Abstract
Empirical evidence shows that the practice of risk management is limited and does not correspond to the prescriptions of the academic literature. In particular, the practice focuses on hedgin g transactions exposures and a firm’s hedge ratios depend on the views of the managers of that firm.
In this paper, we provide a new approach to risk management that is consistent both with the main results of the academic literature but takes into account the factthat firms can have a comparative advantage in bearing some kinds of risks. We examine the implications of this new approach for the management of risk management and for risk measures such as Var.
1
1. Introduction.
This article explores a paradox in the current practice of risk management. Academic research argues strongly that risk management creates value. Most of the academic research focuses on risk management that decreases variability of firm value or cash flows. Despite this academic literature, however, the practice of risk management is rather limited and it does not seem to correspond to the recommendations of academics. Does this mean that academic theories of risk management are not useful? Is there too little risk management? Is it the right kind of risk management?
In the first part of this article, I review some evidence we have about risk management practice. Part of this evidence has to do with the derivative losses of the past few years. What do these losses tell us about
Revised, September 1996
*Bower Fellow, Harvard Business School; Reese Chair in Banking and Monetary Economics, The
Ohio State University; Research Associate, National Burea of Economic Research. I am grateful for u comments to Steve Figlewski, Andrew Karolyi, Robert Whaley, and participants at a seminar t a McKinsey, at the Annual Meetingof the International Association of Financial Engineers, and at the
French Finance Association.
Abstract
Empirical evidence shows that the practice of risk management is limited and does not correspond to the prescriptions of the academic literature. In particular, the practice focuses on hedgin g transactions exposures and a firm’s hedge ratios depend on the views of the managers of that firm.
In this paper, we provide a new approach to risk management that is consistent both with the main results of the academic literature but takes into account the factthat firms can have a comparative advantage in bearing some kinds of risks. We examine the implications of this new approach for the management of risk management and for risk measures such as Var.
1
1. Introduction.
This article explores a paradox in the current practice of risk management. Academic research argues strongly that risk management creates value. Most of the academic research focuses on risk management that decreases variability of firm value or cash flows. Despite this academic literature, however, the practice of risk management is rather limited and it does not seem to correspond to the recommendations of academics. Does this mean that academic theories of risk management are not useful? Is there too little risk management? Is it the right kind of risk management?
In the first part of this article, I review some evidence we have about risk management practice. Part of this evidence has to do with the derivative losses of the past few years. What do these losses tell us about