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AD610 Lecture Notes - Week 3

by: Melissa Wadman

AD610 Lecture Notes - Week 3 MET AD 641

Melissa Wadman
GPA 3.78

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Keywords: Uncertainty - lack of complete certainty, that is, the existence of more than one possibility; the true outcome / state / result / value is unknown Risk - state of uncertainty where s...
Enterprise Risk Management
Class Notes
Risk, Management, liability, mitigation, assessment, profile
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This 2 page Class Notes was uploaded by Melissa Wadman on Wednesday September 21, 2016. The Class Notes belongs to MET AD 641 at Boston University taught by Banasiewicz in Fall 2016. Since its upload, it has received 15 views. For similar materials see Enterprise Risk Management in Administrative Sciences at Boston University.

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Date Created: 09/21/16
  Enterprise Risk Management ­ MET AD 610  Week 3 Lecture No es ➔ Keywords:    ◆ Uncertainty ​­ lack of complete certainty, that is, the existence of more than one possibility; the true outcome / state /  result / value is unknown  ◆ Risk ​­ state of uncertainty where some of the possibilities involve a loss, catastrophe, or other undesirable outcome  ◆ Liability​ ­ any action that puts an individual or group at a disadvantage or creates a hindrance; legally bining  obligation or responsibility  ◆ Risk profile​ ­ a bundle of characteristics, some of which represent traits that the organization shares with high risk  prototype, while others represent traits that the organization shares with low risk prototype.   ◆ Exchange risk ​= expected utility ­ realized utility  ◆ Total risk exposure​ ­ present value of upside risk + present value of downside risk    ★ THREATS  ○ Speculative threats  ■ Uncertainty ­ non­estimable  ● May have never happened before, or so infrequently that it is not considered. Needs to have a  mathematical basis to use effectively  ■ Risk ­ estimable  ● Has already happened, predictable; auto insurance companies have a plethora of data regarding  different types of accidents/claims so it is fairly easy to calculate the frequency of the threat  ○ Non­speculative threats  ■ Liability ­ defined  ● Clearly outlined and disclosed rules, expectations or responsibilities that if not followed will result  in a negative consequence; very clearly communicated and agreed upon    ★ Risk as a threat/​DOWNSIDE RISK​: possibility of asset­damaging or loss­generating events taking place; minimizing the  likelihood of loss­generating events  ○ EXTERNAL  ■ Not controllable: financial, market, political, economic, natural, socio­cultural, environmental, technological  ■ Controllable: regulatory, professional, supply chain  ○ INTERNAL   ■ Managerially­controlled: compliance, operational, reputational  ★ Competitive advantage    ★ Risk as an opportunity/​UPSIDE RISK​: reflects the chances of anticipated growth not materializing; maximizing potential for  growth  ○ Downside   ■ POLITICAL FORCES  ­  shaping force  ● Illegal behaviors: securities violations, dereliction of duty, deception  ● Inadequate controls: employment practices, trade practices, fiduciary duties, supply chain  management  ■ JUDICIAL FORCES  ­  shaping force  ● Negligence: product liability, service liability  ○ Dimension ­­ Executive Threat  ○ Upside  ■ MARKET FORCES  ­  shaping force  ● Ineffective decisioning: performance ­ ​economic  ■ POLITICAL FORCES  ­  shaping force  ● Societal inattentiveness: performance ­ ​societal    ★ RISK ASSESSMENT   ○ Identification: specific and distinct threats to the organization need to be singled out in an operationally clear manner    Enterprise Risk Management ­ MET AD 610  Week 3 Lecture No es ○ Estimation: likelihood and severity need to be estimated in terms of their potential impact  ○ Mapping: individual risks need to be pulled together into a single, coherent picture of the overall threat to the  organization  ○ Response: taking action is a logical consequence of the previous 3 steps  ■ Avoidance ­ exiting out of activities that give rise to risks that are to be avoided  ■ Reduction ­ taking specific steps to reduce the likelihood and/or severity of specific risk types; ‘risk  mitigation’  ■ Transfer ­ insuring, sharing or otherwise outsourcing specific risks  ■ Acceptance ­ generally entails no action, either as a result of explicit cost­benefit analysis or because no  other options are available  ○ Capitalization    ★ RISK ESTIMATION  ○ Risk type  ■ Likelihood vs severity → exposure (risk)  ○ Facts vs. Estimates  ■ Facts happened in the past = data;   ■ estimates are use for the future = projections  ○ Volatility: A dispersion or variability about the average (e.g., mean); Variance is a statistical measure of volatility;  ■ Outliers are actual events that happened ­­ they shouldn’t be discounted  ● Upside variance  ● Downside variance  ■ Would you view a stock with a significantly greater upside volatility differently from one with a significantly  greater downside volatility (everything else being equal)  ○ Probability: an expression of historical/past volatility applied to expectations regarding the future (probability +  likelihood are synonymous  ■ Univariate = only one variable  ■ Multivariate = several variables to be considered against one risk  ○ Frequentist: based strictly on projecting past occurrences into the future  ○ Bayesian: combines a priori (pre­existing) belief with projection (into the future) of past occurences    ★ RISK PROFILING: The Basic Idea  ○ Historically, risk management was approached from the standpoint of cost containment ­­ currently, leading  organizations approach risk management as a source of competitive advantage  ■ Upside risk (maximize benefits)/Downside risk (minimize costs) = Competitively advantageous risk profile  ○ To manage risk is to exploit downside threats as well as upside opportunities in a manner that makes a ​positive  contribution to the firm’s competitiveness  ■ A ​good risk taker​ is a firm whose value increases as a result of its risk management  ■ A ​poor risk taker​ is a firm whose value decreases as a result of its risk management  ​ ​ ○ HIGH RISK prototype vs. LOW RISK prototype ­­ An organizatio​ isk profile can be viewed as a bundle of  characteristics, some of which represent traits that the organization shares with high risk prototype, while others  represent traits that the organization shares with low risk prototype.   ○ THREAT EXPOSURE is relative; from the standpoint of competition, an organization­specific exposure to individual  threats needs to be evaluated in relation to that organization’s peers  ○ a larger process:  ■ Speculative threats → estimable risk → risk exposure → threat exposure  ○ Use rational processes 


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