Corporate Risk Management, 2nd Edition

2

The Concept of Risk and Uncertainty and the Sources and Types of Risk

Man plans, God smiles

(Hebrew proverb)

Fortune favours the prepared

(Louis Pasteur)

2.1 INTRODUCTION

Risk affects every aspect of human life; we live with it every day and learn to manage its influence on our lives. In most cases this is done as an unstructured activity, based on common sense, relevant knowledge, experience and instinct.

This chapter outlines the basic concept of risk and uncertainty and provides a number of definitions of them. It also discusses the dimensions of risk and the perception of risk throughout an organisation. Different sources and types of risk are also discussed.

2.2 BACKGROUND

Uncertainty affects all investments. However, uncertainty can often be considered in terms of probability provided sufficient information is known about the uncertainty. Probability is based on the occurrence of any event and thus must have an effect on the outcome of that event. The effect can be determined on the basis of the cause and description of an occurrence. For example, the cause, description and effect can be illustrated by the following:

‘Crossing the road without looking’ will most likely result in ‘injury’.

Figure 2.1 illustrates the concept of risk in terms of uncertainty, probability, effect and outcome.

Figure 2.1 The concept of risk (Merna and Smith 1996) (Reproduced by permission of A. Merna)

Once the probability, cause and effect of an occurrence can be determined then a ...