Managing Extreme Financial Risk

Chapter 2

Tail Risk is the Culprit

Tail Wagging the Dog?

Abstract

Credit policy function used to be a shield against extreme risk when credit was the primary financial risk at financial institutions. The examples of Continental Bank and Penn Square Bank show that the failure of credit policy function can lead to disastrous results. With increased securitization, today's financial institutions derive a much larger proportion of their revenues from market risk. This has profoundly changed the composition and magnitude of total tail risk. Traditional risk management doesn't have an explicit focus on tail risk akin to credit policy's role. This has resulted in a relative decline of the tail risk watchdog function just when the need for such a ...