Risk Management: Foundations for a Changing Financial World

CHAPTER 2

PRACTICAL ISSUES IN CHOOSING AND APPLYING RISK MANAGEMENT TOOLS^b

Jacques Longerstaey

Effective risk management encompasses many concerns and requires a complete program of organizational capabilities. Defining risk, agreeing on and critiquing measures of risk, and deciding whether to buy or build a risk management model—all are key steps in choosing and applying risk management tools.

Risk management systems range from the overly simple to the numbingly complex. Somewhere in between is the appropriate approach to risk management for most investment management organizations—an approach that addresses key risk exposures with understandable risk measures in a user-friendly risk management model. This presentation focuses on some of the practical issues involved with trying to implement a risk management framework—issues that include defining risk, agreeing on risk measures, recognizing deficiencies in such widely used measures as tracking error, and deciding whether to buy or build the appropriate risk measurement models.

EFFECTIVE RISK MANAGEMENT

Gerald Corrigan, former president of the New York Federal Reserve Bank, described risk management as getting the right information to the right people at the right time. His description is more telling than its brevity might suggest. The “right information” refers to having enough, but not too much, information. Many risk management reporting systems get bogged down in a mass of information, and the danger is that the system ...