Corporate Risk Management

Introduction

GENERAL PRESENTATION

The study of financial risk management began after World War II. This rather young discipline aims to reduce the costs associated with risk. It covers all risk categories.

Risks cause various types of costs: physical, economic, financial, and even psychological. Some are insurable and others are not. This book concentrates on economic and financial risks that businesses and individuals face, especially those that are not anticipated, although some anticipated risks are also discussed. The costs of risk are generated not only by passive exposure to hazards, but also by risk taking in hazardous environments linked notably to the competition, technology, debt, economic conditions, climatic conditions, market imperfections, and regulations, although regulations may also mitigate the social costs of some risks.

Risk management does not imply risk aversion. It may concern risk-averse decision makers, but risk aversion is not a necessary condition for its use. It is well known that an increase in risk (mean preserving spread) decreases the welfare of risk-averse decision makers, but it also reduces the value of firms that have a concave objective function. This concavity may be obtained by a moderate risk appetite along with an exposure to nonlinear financial products, and by market imperfections such as the convexity of tax functions, or information asymmetry in financial markets.

Under the regulations governing banks and insurance companies, the risk ...