LibGuides: Module RSK4803: Prescribed and Recommended Material

Prescribed articles

1. Greener, I. 2006. Nick Leeson and the Collapse of Barings Bank: Socio-Technical Networks and the ‘Rogue Trader'. Organization. Vol. 13(3): 421-441. This paper examines the collapse of Barings Bank, utilizing an extended analytical framework based on Callon’s sociology of translation.It shows how Leeson linked himself inextricably with Barings’ executives need for profit, mobilizing them (and others) into defending him when his activities were subject to scrutiny. It goes on to explain the process through which Leeson effectively lost control of his socio-technical network, and concludes by examining the difficulty of Leeson’s presentation of himself to the world as a ‘rogue trader’.
2. R Stulz. 2008. Risk Management Failures: What are they and when do they happen? Journal of Applied Corporate Finance Vol. 20 No. 4:28-51 The difficulties of the past year have convinced many observers that current risk management practices are deeply flawed, and that such flaws have contributed greatly to the current financial crisis. In this paper, the author challenges this view by showing the need to distinguish between flawed assessments by risk managers and corporate risk‐taking decisions that, although resulting in losses, were reasonable at the time they were made. In making this distinction, the paper also identifies a number of different ways that risk management can fail. In addition to choosing the wrong risk metrics and misidentifying or mismeasuring risks, risk managers can fail to communicate their risk assessments and provide effective guidance to top management and boards. And once top management has used that information to help determine the firm's risk appetite and strategy, the risk management function can also fail to monitor risks appropriately and maintain the firm's targeted risk positions. But if risk management has been mistakenly identified as the culprit in many cases, current risk management practice can be improved by taking into account the lessons from financial crises past and present. In particular, such crises have occurred with enough frequency that crisis conditions can be modeled, at least to some extent. And when models reach their limits of usefulness, companies should consider using scenario planning that aims to reveal the implications of crises for their financial health and survival. Instead of relying on past data, scenario planning must use forward‐looking economic analysis to evaluate the expected impact of sudden illiquidity and the associated feedback effects that are common in financial crises.
3. Bennett, N & James Lemoine, GJ. 2014. What a difference a word makes: Understanding threats to performance in a VUCA world. Business Horizons 57:311–317. VUCA is an acronym that has recently found its way into the business lexicon. The components it refers to—volatility, uncertainty, complexity, and ambiguity—are words that have been variously used to describe an environment which defies confident diagnosis and befuddles executives. In a ‘VUCA world,’ both pundits and executives have said, core activities essential to driving organizational performance—like strategic planning—are viewed as mere exercises in futility. VUCA conditions render useless any efforts to understand the future and to plan responses. When leaders are left with little to do other than wring their hands, organizational performance quickly falls at risk. In this installment of Organizational Performance, we demonstrate that by overlooking important differences in the conditions that volatility, uncertainty, complexity, and ambiguity describe, we have disempowered leaders. We show how leaders can appreciate the differences among each of these challenging situations in order to properly allocate scarce resources to preserve and enhance organizational performance.
4. McMillan, C & Overall, J. 2016. Wicked problems: turning strategic management upside down. Journal of Business Strategy 37(1):34–43. Purpose - The purpose of this paper is to critique the existing decision-making models of organizational theory and the ability of strategic managers to address unconventional problems using these models. Strategic management models presume reasonable stability in the task environment and the organizational design features. However, complex problems, or wicked problems, are prolific in a global world. They change profoundly the nature of strategic management, where management faces a deep paradox - an environment of unprecedented interdependence, yet unpredictable forces of chaos and volatility, a landscape of wicked problems. In this paper, the authors address wicked problems within the context of strategic management.
5. Bonabeau, E. 2007. Understanding and managing complexity risk. MIT Sloan Management Review 48(4):62-68. In the past, companies have tried to manage risks by focusing on potential threats outside the organization: competitors, shifts in the strategic landscape, natural disasters or geopolitical events. They are generally less adept at detecting internal vulnerabilities that creep into organizations and other human-designed systems. Indeed, as companies increase the complexity of their systems products, processes, technologies, organizational structures, legal contracts and so on they often fail to pay sufficient attention to the introduction and proliferation of loopholes and flaws. Ericsson, Barings Bank and Comair are but a few examples of companies that have suffered disastrous breakdowns in their complex internal systems. A crucial thing to remember is that the possibility of random failure rises as the number of combinations of things that can go wrong increases, and the opportunity for acts of malicious intent also goes up. Build new applications on top of legacy systems, and errors creep in between the lines of code. Merge two companies, and weaknesses sprout between the organizational boundaries. Build Byzantine corporate structures and processes, and obscure pockets are created where bad behavior can hide. Furthermore, the enormous complexity of large systems like communications networks means that even tiny glitches can cascade into catastrophic events. In fact, catastrophic events are almost guaranteed to occur in many complex systems, much like big earthquakes are bound to happen. So, without the benefit of perfect foresight, how can businesses uncover and forestall the fatal flaws lurking within their organizations? There are three complementary strategies: (1) Assess the risk to make better-informed decisions, such as purchasing an insurance policy to cover the risk; (2) spot vulnerabilities and fix them before catastrophic events occur; and (3) design out weaknesses through resilience. These ideas have been around for years, but researchers have recently had to reinvent them in the context of extremely complex, interconnected cascade-prone systems. [PUBLICATION ABSTRACT]
6. Ellen F. Goldman. 2007. Strategic thinking at the top. MIT Sloan Management Review 48(4):75-81. Business schools and others interested in management education and development have vigorously debated how best to teach strategy to future leaders. Some experts have questioned whether the topic should be taught at all or at least whether it should be taught to managers. Often missing from the debate, however, has been any in-depth discussion of how individuals learn to think strategically in the first place. What specific experiences are important and how do they contribute? Moreover, what are the different ways in which people absorb those experiences to develop the ability to think strategically? To answer these and other questions, the author conducted a study that identified executives who were considered the top strategic thinkers in their industry. The study then investigated the totality of experiences (educational, job related or other) that contributed to the high ability of those individuals. In addition, the research investigated the different ways in which the executives acquired their expertise in strategic thinking - a process that typically took more than a decade The data showed that strategic thinking arises from 10 specific types of experiences for instance, spearheading a major growth initiative or dealing with a threat to organizational survival. Moreover, executives appear to gain their expertise in strategic thinking through one of three developmental patterns. These findings help demystify the process by which strategic thinking is learned, offering important implications for management development and the practice of strategy. [PUBLICATION ABSTRACT]
7. Hinrichs, J. 2009. Creating synergy by integrating enterprise risk management and governance. Journal of Risk Management in Financial Institutions 2(2):155–164. Enterprise risk management and governance are inextricably linked to the quality and effectiveness of risk management. This paper examines the risk management weaknesses related to some recent unanticipated events in financial institutions, including specific examples related to New Century Financial, UBS and Société Générale. It also looks at how more effective integration of ERM and governance might have improved the outcomes, with a particular focus on transparency of risk exposures. Effective ERM complements governance, and good governance complements an effective ERM programme. Synergy is created when they are integrated effectively. [ABSTRACT FROM AUTHOR]
8. Rodriguez, E & Edwards, JS. 2009. Applying knowledge management to enterprise risk management: Is there any value in using KM for ERM. Journal of Risk Management in Financial Institutions 2(4):427–437. In many organisations, there is no clear relationship between risk management and the practice of knowledge management. By adopting knowledge management processes, organisations can improve enterprise-wide implementation of risk management. This paper considers the application of processes to enterprise risk management (ERM), concentrating in the first instance on knowledge sharing. Within a cluster, the results show a possible relationship between the quality of knowledge sharing and system integration and the perceived value of ERM. In general, the relationship between the perceived value of ERM and knowledge sharing is significant but low. [ABSTRACT FROM AUTHOR]
9. Ai, J, Brocket, PL & Wang, T. 2017. Optimal enterprise risk management and decision making with shared and dependent risks. Journal of Risk and Insurance 84(4):1127–1169. Dynamic enterprise risk management (ERM) entails holistic decision making for critical corporate functions such as capital budgeting and risk management. The interplay across business divisions, however, is complicated due to their natural interactions through risk exposures that are shared and dependent across an intricate corporate structure. This article develops an integrated optimization framework via a copula‐based decision tree interface to facilitate ERM decision making to meet the specified enterprise goal in a multiperiod setting. We illustrate our model and provide managerial insights with a case study for a financial services company engaged in both banking and insurance businesses.
10. Buytendijk, F, Hatch, T & Micheli, P. 2010. Scenario-based strategy maps. Business Horizons. (53):335—347. Strategy maps are designed to help execute strategy and bring predictive qualities to key performance indicators by linking them according to perceived cause-and-effect relationships. However, in our experience strategy maps are often extrapolations of past performance and are seldom sufficiently linked to possible future states. In this article, we argue that scenario analysis could play an important role in the design of strategy maps, as it is an effective method to look at the future. Through the development of scenarios, organizations can think creatively about possible discontinuous future states and can prepare themselves for multiple plausible futures, not only the one they expect to happen. Therefore, scenario-based strategy maps could enable organizations to face strategic uncertainty in a more effective way and make them more sustainable in the longer term. This article highlights the strengths and weaknesses of strategy maps and scenario analysis, and outlines a method to develop scenario-based strategy maps both in theory and by presenting a significant example.
11. Merton, RC & Perold, AF. 1993. Theory of risk capital in financial firms. Journal of Applied Corporate Finance Fall (6)3:16-32. We present a theory of risk capital and of how tax and other costs of risk capital should be allocated in a financial firm. Risk capital is equity investment that backs obligations to creditors and other liability holders and maintains the firm’s credit quality. Credit quality is measured by the ratio of the value of the firm’s option to default to the default-free value of its liabilities. Marginal default values provide a full and unique allocation of risk capital. Efficient capital allocations maintain credit quality and preclude risk shifting. Our theory leads to an adjusted present value (APV) criterion for making investment and contracting decisions. We relate our results to capital budgeting procedures used in corporate finance. We also set out practical and policy applications, including implications for risk-based regulatory capital requirements.
12. Shimpi, P. 2002. Integrating Risk Management and Capital Management. Journal of Applied Corporate Finance Winter (14)4: 27-40. Capital management and risk management are two sides of the same coin. But by treating them separately, the conventional theory and practice of corporate finance fails to account for important connections between them. Moreover, an exclusive focus on debt and equity ignores the full range of capital resources available to a corporation, thus distorting management's view of the firm's cost of capital (and its return on equity). An understanding of the role of corporate capital–including off‐balance sheet as well as paid‐up capital—and its relationship to the riskiness of a firm's activities provides the foundation on which the author builds a corporate finance framework that ties together both the insurance and capital markets. This framework, called the “Insurative Model,” captures the economics of both conventional insurance and corporate finance instruments and embraces a wide variety of solutions and instruments—be they debt, equity, insurance, derivative, contingent capital, or any other—and allows managers to evaluate their effectiveness in a consistent, unified way. The Insurative Model demonstrates that a company's decisions on insurance and risk retention can be just as important as its decisions about its debt‐equity mix. In fact, the determination of a firm's optimal debt‐equity ratio should be the last in a series of capital and risk management decisions. Earlier decisions should address risk retention, risk transfer, and the optimal amounts and structure of off‐balance‐sheet capital used to support the company's retained risks.
13. Doherty, NA. 2005. Risk Management, Risk Capital, and the Cost of Capital. Journal of Applied Corporate Finance Summer (17)3:119-123. In a recent JACF article, Prakash Shimpi proposed a new way of calculating a firm's cost of capital that incorporated a concept of “risk capital” as well as operational capital. The premise of the Shimpi approach was that purchasing hedging instruments effectively “releases” equity that is no longer needed to ensure the firm's creditworthiness. This article shows that Shimpi's cost of capital calculations incorporate this released equity in a misleading way, exaggerating the capital base and underestimating its true cost. It also demonstrates how conventional cost of capital approaches can be modified to integrate risk capital, thereby avoiding such distortions and accurately representing the cost of capital of a company with a policy of active risk management.
14. O’Brien, TJ. 2006. Risk Management and the Cost of Capital for Operating Assets. Journal of Applied Corporate Finance (18)4:105-109 This article attempts to clarify the effect of risk management on a company's cost of capital in the spirit of the traditional M&M/CAPM model. The traditional cost of capital model can and should be used to find the hurdle rate for a company's operating assets, since it can be applied regardless of the composition of the firm's non‐operating assets or its risk management policy. The author's main message is that if a firm manages idiosyncratic risk, the correct cost of capital for the operating investment is not the firm's enterprise WACC, but rather the required return on the assets being funded. Using the case of a company with a single line of business that is evaluating an investment opportunity, the author demonstrates how to adjust the firm's overall WACC to find the cost of capital for the operating assets to be acquired.
15. Heine, R & Harbus, F. 2002. Toward a More Complete Model of Optimal Capital Structure. Journal of Applied Corporate Finance. Spring (15):1.31-45. Most corporate finance practitioners understand the trade‐off involved in making effective use of debt capacity while safeguarding the firm's ability to execute its business strategy without disruption. But quantifying that trade‐off to arrive at an optimal level of debt can be a complicated and challenging task. This paper develops a simulation model of capital structure that starts by generating multiple estimates of market rates (LIBOR, currency rates) and corresponding company operating cash flows. To arrive at an optimal capital structure, the model then incorporates the shareholder value effects of alternative financing decisions by directly measuring the costs of financial distress, including the costs of missed investment opportunities and higher working capital requirements. The model generates both a target credit rating and a lower fallback rating that permits a higher level of debt to maintain investments and dividends when operating cash flows are weak. As the model shows, companies with volatile cash flows and significant investment opportunities can add substantial shareholder value by establishing a fallback credit rating that is one or two notches below the target rating. The model also optimizes the mix of fixed versus floating debt, the maturity structure, and the currency composition. Another distinctive feature of the model is its ability to estimate the expected cost of alternative liability structures that can provide the liquidity insurance necessary to sustain the firm through periods of severe stress. This cost turns out to be quite small relative to the total market capitalization of the average firm.
16. Mulvey, John M, Madsen, C & Morin, F. 1999. Linking strategic and tactical planning systems for asset and liability management. Annals of Operations Research 85(17):249–266. Total enterprise risk management involves a systematic approach for evaluating/controlling risks within a large firm such as a property‐casualty insurance company. The basic idea is to coordinate planning throughout the organization, from traders and underwriters to the CFO, in order to maximize the company's economic surplus at the desired level of enterprise risk. At present, it is difficult to link strategic systems, such as asset allocation, to tactical systems for pricing securities and selecting new products. We propose two solutions. First, we develop a “price of risk” for significant decisions possessing correlated factors. Second, we create a set of dynamic investment categories, called hybrid assets,for use in an asset and liability management framework. We illustrate the concepts via an insurance planning problem, whereby the goal is to optimize the company's surplus.
17. Metzger, MB. 2010. Problems with probabilities. Business Horizons (53): 15–19.
18. Neth, H., Meder, B., Kothiyal, A. & Gigerenzer, G. 2014. Homo heuristicus in the financial world: From risk management to managing uncertainty. Journal of Risk Management in Financial Institutions 7(2):134–144. What -- if anything -- can psychology and decision science contribute to risk management in financial institutions? The turmoils of recent economic crises undermine the assumptions of classical economic models and threaten to dethrone Homo oeconomicus, who aims to make decisions by weighing and integrating all available information. But rather than proposing to replace the rational actor model with some notion of biased, fundamentally flawed and irrational agents, we advocate the alternative notion of Homo heuristicus, who uses simple, but ecologically rational strategies to make sound and robust decisions. Based on the conceptual distinction between risky and uncertain environments this paper presents theoretical and empirical evidence that boundedly rational agents prefer simple heuristics over more flexible models. We provide examples of successful heuristics, explain when and why heuristics work well, and illustrate these insights with a fast and frugal decision tree that helps to identify fragile banks. We conclude that all members of the financial community will benefit from simpler and more transparent products and regulations. [ABSTRACT FROM AUTHOR]
19. Bantz, DA. 1982. The Philosophical Basis of Cost-Risk-Benefit Analyses. PSA: Proceedings of the Biennial Meeting of the Philosophy of Science Association, Volume Two: Symposia and Invited Papers pp 227-242 Analytical techniques for determining the net worth of the consequences of alternative choices are increasingly used to motivate decisions about public projects and policies, especially where risks are prevalent. What information do these techniques provide, and what are the grounds for using them in decision making? It is argued that the apparent similarities of cost-risk-benefit analyses to decision theory are in some ways misleading, and that the true basis of such analyses in welfare economics suggests some inherent limitations to their use. The limitations described arise from the practice of aggregating individual preferences as determined by economic valuations; they restrict (but do not invalidate) the application of such analyses.
20. Rowell, D & Connelly, LB. 2012. A history of the term “Moral Hazard”. Journal of Risk and Insurance 79(4):1051–1075. The term “moral hazard” when interpreted literally has a strong rhetorical tone, which has been used by stakeholders to influence public attitudes to insurance. In contrast, economists have treated moral hazard as an idiom that has little, if anything, to do with morality. This article traces the genesis of moral hazard, by identifying salient changes in economic thought, which are identified within the medieval theological and probability literatures. The focus then shifts to compare and contrast the predominantly, normative conception of moral hazard found within the insurance‐industry literature with the largely positive interpretations found within the economic literature.
21. Carther, D. 2010. A gentle introduction to risk aversion and utility theory. Risk Management and Insurance Review 13(1):127–145. While the topics of risk aversion and utility theory have been discussed extensively in the academic literature on risk and insurance, this literature does not include a pedagogical discussion that is widely accessible for classroom use. This article provides a practical introduction to risk aversion that is designed for readers with little prerequisite course work in economics or statistics. We describe a simple model of insurance demand that can be applied to the property, liability, life, and health insurance markets. We also demonstrate how risk aversion affects a variety of real‐life insurance decisions made under conditions of uncertainty, including how much the market will bear to pay for insurance administrative expenses and how demand varies for different types of auto insurance coverage. Exercises and practice problems are provided so that readers can test their mastery of the concepts presented in the article. An instructional note on using this article to teach risk aversion in the classroom is also provided.
22. Fishburn, P.1989. Retrospective on the Utility Theory of von Neumann and Morgenstern. Journal of Risk and Uncertainty 2:127–158. This article offers an exegesis of the passages in von Neumann and Morgenstern (1944, 1947, 1953) that discuss their conception of utility. It is occasioned by two factors. First, as we approach the semicentennial of the publication of Theory of Games and Economic Behavior, its immense impact on economic thought in the intervening years encourages serious reflection on its authors' ideas. Second, misleading statements about the theory continue to appear. The article will have accomplished its purpose if it helps others appreciate the genius and spirit of the theory of utility fashioned by John von Neumann and Oskar Morgenstern.
23. Smit, HTJ. & Trigeorgis, L. 2017. Strategic NPV: Real Options and Strategic Games under Different Information Structures. Strategic Management Journal 38: 2555–2578. Research summary: Among the most difficult firm strategic choices is the trade‐off between making a long‐term commitment or holding off on investment in the face of uncertainty. To operationalize strategic management theory under demand, technological and competitive uncertainty, we develop a Strategic Net Present Value (NPV) framework that integrates real options and game theory to quantify value components and interactions at the interface between NPV, real options, and strategic games. Our approach results in new propositions clarifying the way learning‐experience conditions, technological uncertainty, and proprietary information interact to tilt the balance in the interplay between wait‐and‐see flexibility and strategic commitment. As such, Strategic NPV adds to our understanding of the conditions where NPV, real options, or strategic thinking are more relevant. Managerial summary: This study develops and elucidates implementation of a new valuation construct, “Strategic Net Present Value (NPV),” that integrates real options and game theory to more accurately portray strategic decisions underlying management theory. Among the most difficult firm strategic choices in capital intensive industries, such as energy, mining, chip manufacturing, and infrastructure development, is the trade‐off between making a long‐term commitment or holding off on investment in the face of demand, technological, and competitive uncertainties. The study provides new insights on the way various conditions, such as learning‐experience effects, technological uncertainty, and proprietary information, interact to tilt the balance in the interplay between commitment and wait‐and‐see flexibility. As such, Strategic NPV adds to our understanding of when NPV, real options, or strategic thinking matter more critically for decision making.
24. Reid, J. 1995. The Cost of Risk and the Concept of Risk Partnership. The Geneva Papers on Risk and Insurance 20 (No. 76, July) 279-283. A recent survey in UK has highlighted the large discrepancy between the insured and uninsured costs of losses, demonstrating that the true cost of risk is much higher than previous estimates. Risk is never totally transferred by insurance, and if insureds recognise that they retain a partial ownership of the risk there is a greater likelihood that there will be better loss control. The paper promotes the concept of "risk partnership" as a more correct representation of the contract between insurer and insured than the more generally used term of "risk transfer".
25. Spackova, O & Straub, D. 2015. Cost-Benefit Analysis for Optimization of Risk Protection Under Budget Constraints. Risk Analysis 35(5):941-959. Cost‐benefit analysis (CBA) is commonly applied as a tool for deciding on risk protection. With CBA, one can identify risk mitigation strategies that lead to an optimal tradeoff between the costs of the mitigation measures and the achieved risk reduction. In practical applications of CBA, the strategies are typically evaluated through efficiency indicators such as the benefit‐cost ratio (BCR) and the marginal cost (MC) criterion. In many of these applications, the BCR is not consistently defined, which, as we demonstrate in this article, can lead to the identification of suboptimal solutions. This is of particular relevance when the overall budget for risk reduction measures is limited and an optimal allocation of resources among different subsystems is necessary. We show that this problem can be formulated as a hierarchical decision problem, where the general rules and decisions on the available budget are made at a central level (e.g., central government agency, top management), whereas the decisions on the specific measures are made at the subsystem level (e.g., local communities, company division). It is shown that the MC criterion provides optimal solutions in such hierarchical optimization. Since most practical applications only include a discrete set of possible risk protection measures, the MC criterion is extended to this situation. The findings are illustrated through a hypothetical numerical example. This study was prepared as part of our work on the optimal management of natural hazard risks, but its conclusions also apply to other fields of risk management.
26. Graham, J & Campbell, H. 2002. How Do CFOs Make Capital Budgeting and Capital Structure Decisions? Journal of Applied Corporate Finance 15(1):8–23. This paper summarizes the findings of the authors' recent survey of 392 CFOs about the current practice of corporate finance, with main focus on the areas of capital budgeting and capital structure. The findings of the survey are predictable in some respects but surprising in others. For example, although the discounted cash flow method taught in our business schools is much more widely used as a project evaluation method than it was ten or 20 years ago, the popularity of the payback method continues despite shortcomings that have been pointed out for years. In setting capital structure policy, CFOs appear to place less emphasis on formal leverage targets that reflect the trade‐off between the costs and benefits of debt than on “informal” criteria such as credit ratings and financial flexibility. And despite the efforts of academics to demonstrate that EPS dilution per se should be irrelevant to stock valuation, avoiding dilution of EPS was the most cited reason for companies reluctance to issue equity. But despite such apparent contradictions between theory and practice, finance theory does seem to be gaining ground. For example, large companies were much more likely than their smaller counterparts to use DCF and NPV techniques, while small firms still tended to rely heavily on the payback criterion. And a majority of the CFOs of the large companies said they had “strict” or “somewhat strict” target debt ratios, whereas only a third of small firms claimed to have such targets. What does the future hold? On the one hand, the authors suggest that we are likely to see greater corporate acceptance of certain aspects of financial theory, including the use of real options techniques for evaluating corporate investments. But we are also likely to see further modifications and refinements of the theory, particularly with respect to smaller companies that have limited access to capital markets.
28. Culp, CL. 2002. Contingent Capital: Integrating Corporate Financing and Risk Management Decisions. Journal of Applied Corporate Finance. Spring 2002 Volume 15.1. Financial executives of companies that face a sharp increase in business or financial risks have two basic ways of protecting the solvency and strategic viability of their organizations: they can transfer those risks using insurance or derivatives; or they can raise additional capital, typically by issuing equity, to cushion the firm against the higher expected volatility. But CFOs now also have a third means of managing risk, known as “contingent capital,” that effectively combines capital raising and risk management. A contingent capital facility gives a company the right to raise capital after the realization of a loss arising from one or more specified risks, thus ensuring access to capital in potentially difficult times. For example, Swiss Re recently granted Michelin a five‐year right to issue ten‐year subordinated debt at a fixed spread over LIBOR, though only under conditions in which the tire maker expects its own earnings to be down. To the extent that it eliminates the need to keep more capital on the balance sheet, the use of such contingent capital has the potential to increase shareholder value by reducing a company's overall cost of capital. This article provides an introduction to some recent innovations in contingent capital, along with discussion of their role in integrating corporate finance and risk management.
27. Hofmann, A. & Peter, R. 2016. Self-insurance, self-protection, and saving: On consumption smoothing and risk management. The Journal of Risk and Insurance. Vol. 83, No. 3, 719-734. This article studies the effect of risk preferences on self‐insurance and self‐protection in a two‐period expected utility framework. Here the investment to reduce risk precedes its effect. In contrast to single‐period models, self‐insurance and self‐protection react similarly when the agent's utility function becomes more concave. Effort is increased if and only if current consumption is sufficiently large. However, if we introduce endogenous saving, an agent with more concave utility always selects more self‐insurance, but will select more self‐protection if and only if the probability of loss is small enough. These latter results concur with those in standard monoperiodic models with no saving.
29. Chacko, G., Tufano, P., & Verter, G. 2002. Raising contingent capital: The case of Cephalon. Journal of Applied Corporate Finance. Spring 2002 Volume 15.1. In early 1997, Cephalon, Inc., a biotechnology firm, purchased 2.5 million capped call options on its own stock, with a potential value of as much as $45 million, in exchange for $9.8 million worth of its common shares. Cephalon's first major drug, Myotrophin, was under review by the U.S. Food and Drug Administration, and Cephalon's management reasoned that, upon FDA approval, the company's stock would rise in value to reflect the future value of the drug, in which case the call options would pay off and the firm could use the proceeds to help fund commercialization of the drug. The managers thus viewed the call options as a form of “contingent capital,” capital that would be available only if and when the firm needed it. The availability and cost of financing constitute major uncertainties for any company and perhaps even more so for a biotech firm. But was the options transaction a cost‐effective way to raise capital? The authors' analysis suggests that the cost of the capped calls—underwriting fees, expenses, underpricing, and market impact—was quite high compared to alternative sources of financing that may have been available to Cephalon in the wake of a favorable decision by the FDA. An equally interesting aspect of this case is that the size of Cephalon's funding requirements was determined in large part by accounting rules and management's desire to report higher (non‐cash) earnings.
30. Mostert, JH. & Mostert, FJ. 2008. Finite risk insurance as a form of alternative risk transfer. Corporate Ownership & Control. Vol. 6, No. 1. The concept alternative risk transfer relates to the point where insurance, banking and/or the capital market converge in an attempt to efficiently provide enterprises with sufficient financial capacity for protection against a variety of risks. No single all-embracing definition of the concept exists, as these products are tailor-made to the needs of each client. Finite risk insurance represents a category of alternative risk transfer products. Key features and objectives of finite risk insurance receive due attention, after which the focus shifts to the variants and types of contracts concerned. Loss Portfolio Transfers, Adverse Development Coverage, Spread Loss Coverage and Finite Quota Share Reinsurance are identified as the main types of finite risk insurance. The linking of the financial needs of enterprises and insurers to particular finite risk insurance solutions are illustrated in the next two sections. The closing section of this research paper focuses on future prospects of finite risk insurance.
31. Culp, C. 2005. The uses and abuses of finite risk reinsurance. Journal of Applied Corporate Finance. Vol. 17 No. 3. Finite risk reinsurance has become the subject of investigations, litigation, and possibly new regulation. This article provides an overview of finite risk solutions and products, describing their main features and their legitimate role in helping (mainly) industrial companies manage timing, funding, and insurance risks. Finite risk solutions generally take the form of structured insurance products designed to help companies manage risks often regarded as exotic or “tail” risks, such as environmental or asbestos liability. Although such products are underwritten by insurance or reinsurance companies, they typically involve limited risk transfer (hence the name “finite risk”) while providing the insured companies with a means of pre‐funding their expected losses, or what is often called “pre‐loss financing.” Of course, companies could choose to self‐insure such risks by establishing a reserve for future losses. But finite risk provides a more credible and transparent alternative—one that reassures investors both by capping the liability and eliminating the possibility for manipulation of reserves. Abuses of finite risk products usually concern the degree to which transactions are accounted for, disclosed, and represented to investors as achieving “significant risk transfer” when there is little or no such transfer. In the authors' words, “Users of finite should ask themselves whether the transaction helps the financial statements clearly represent the true economic income and risks of the business and, if not, then consider not doing the deal.”
32. Cummins, & Weiss, 2009. Convergence of insurance and financial markets: hybrid and securitized risk-transfer solutions. Journal of Risk and Insurance, Vol. 76 No. 3: 493–545. One of the most significant economic developments of the past decade has been the convergence of the financial services industry, particularly the capital markets and (re)insurance sectors. Convergence has been driven by the increase in the frequency and severity of catastrophic risk, market inefficiencies created by (re)insurance underwriting cycles, advances in computing and communications technologies, the emergence of enterprise risk management, and other factors. These developments have led to the development of hybrid insurance/financial instruments that blend elements of financial contracts with traditional reinsurance as well as new financial instruments patterned on asset‐backed securities, futures, and options that provide direct access to capital markets. This article provides a survey and overview of the hybrid and pure financial markets instruments and provides new information on the pricing and returns on contracts such as industry loss warranties and Cat bonds.
33. Csiszar, E. 2007. An update on the use of modern financial instruments in the insurance sector. The Geneva Papers on Risk and Insurance. Issues and Practices. Vol. 32. No. 3. Special Issue on Regulation and Supervision. 319-331 The world's financial markets have exploded with new products and new techniques such as derivatives and securitizations, giving rise to huge new markets. The author reviews recent developments in insurance-linked securities (ILS), financial products that link insurance and reinsurance with these new markets. Pricing and availability problems after Hurricane Katrina have led to newer types of products making their way into these markets. While catastrophe bonds still make up a significant portion of ILS, the risk of not recovering reinsurance receivables, for instance, can now be transferred to the financial markets via credit derivatives. Catastrophe risk can also be packaged as a credit derivative. New participants, like hedge funds and specialized mutual funds, have also caused a revival of exchange-traded ILS. Trading in catastrophe futures and weather derivatives is thriving. Sidecars were revived. Contingent capital is readily available. New perils, combined with others, are being covered. Insurance and reinsurance companies can no longer treat these instruments as a matter of relative pricing between traditional products and ILS. After Katrina, access to multiple sources of capital has become an essential strategic objective.
34. Zech, J. 2001. Rethinking Risk Management: The combination of financial and industrial risk. The Geneva Papers on Risk and Insurance. Vol. 26. No. 1. 71-82.
35. Cummins, J. & Trainar, P. 2009. Securitization, Insurance and Reinsurance. The Journal of Risk and Insurance. Vol. 76. No.3, 463-492. This article considers strengths and weaknesses of reinsurance and securitization in managing insurable risks. Traditional reinsurance operates efficiently in managing relatively small, uncorrelated risks and in facilitating efficient information sharing between cedants and reinsurers. However, when the magnitude of potential losses and the correlation of risks increase, the efficiency of the reinsurance model breaks down, and the cost of capital may become uneconomical. At this juncture, securitization has a role to play by passing the risks along to broader capital markets. Securitization also serves as a complement for reinsurance in other ways such as facilitating regulatory arbitrage and collateralizing low‐frequency risks.
36. Mutenga, S. & Staikouras, S. 2007. The Theory of Catastrophe Risk Financing: A Look at the Instruments that Might Transfor the Insurance Industry. The Geneva Papers. 32.222-245 The current study reviews the risk financing techniques employed in the insurance markets and looks at the changing field of the risk management arena. The overarching view is that apart from the traditional channels of financing risk, alternative routes should be explored. The latter is strengthened with the surfacing of off-balance sheet instruments in modern financial markets. The paper extends the discussion to the layered risk financing approach and reinforces its importance. That is, cash flow engineering instruments are employed to match different segments of the loss distributions. The role of insurance risk capital to assume extreme losses is further discussed, while reinsurance still remains a form of capital restructuring. Taken all together, the intention is that risk financing should be able to release assets committed to liabilities, and should reduce the cost of risk capital in sponsoring all-purpose equity. Finally, risk management platforms are redefined, while the securitisation of insurance risk is explored along with its effectiveness and possible caveats.

Recommended Book

Recommended Theses

Recommended Standards

ISO 31000: Risk Management-Guidelines 2018
ISO 31000: Risk Management-Guidelines 2018 has been released in February 2018 and cancels and replaces the first edition (ISO 31000: 2009). It can be used to better position organizations to achieve objectives, improve the identification of opportunities and threats, and effectively allocate and use resources for risk treatment.

Recommended Frameworks

Committee of Sponsoring Organizations of the Treadway Commission (COSO) Enterprise Risk Management Framework
The Framework defines essential enterprise risk management components, discusses key ERM principles and concepts, suggests a common ERM language, and provides clear direction and guidance for enterprise risk management

COSO Enterprise Risk Management by Robert R. Moeller
Call Number: Electronic book
ISBN: 9781118269145
Publication Date: 2011-12-20
Executive's Guide to COSO Internal Controls by Robert R. Moeller
Call Number: 657.458 MOEL
ISBN: 9781118626412
Publication Date: 2013-12-31
The revised COSO internal controls framework Executive's Guide to COSO Internal Controls provides a step-by-step plan for installing and implementing effective internal controls with an emphasis on building improved IT as well as other internal controls and integrating better risk management processes. The COSO internal controls framework forms the basis for establishing Sarbanes-Oxley compliance and internal controls
Enterprise risk management : integrating with strategy and performance.. by Committee of Sponsoring Organizations of the Treadway Commission
Call Number: 658.155 ENTE
ISBN: 9781945498855
Publication Date: 2017