Risk evaluation is a complex process encompassing qualitative and quantitative methods. When properly carried out, risk analysis yields results with lasting value that transcend mere decision-support applications; its outcomes must therefore be documented for posterity.
Planning and scoping stages serve two critical purposes in any decision context: creating a conceptual model which specifically identifies stressors, sources, receptors, exposure pathways and adverse effects; and an analysis plan.
What is Risk?
Risk can be defined as the potential to experience loss or disruption, and individuals, financial advisors and companies all employ strategies to minimize losses by evaluating risks related to investments.
An effective risk analysis must identify all potential hazards, which includes both negative effects like financial losses and disruptions as well as any positive potential benefits that might emerge from their identification.
To accurately assess risks, various methods, metrics, and theories can be employed. Some are quantitative, such as standard deviation which measures volatility of values; others, like expert judgment or Delphi methods can provide more qualitative assessments.
Planning and scoping are the initial steps in risk evaluation, undertaken collaboratively between decision-makers and stakeholders, to establish why an assessment is being conducted, set its boundaries (such as time, space, regulatory options, impacts and risk criteria) as well as establish its scope and complexity (EPA 2003). At this point communication about risks should commence (EPA 2003).
Types of Risks
Businesses face numerous risks that need to be evaluated and managed, including financial, operational, credit and reputational risks. Reputational risks arise from any negative events which might damage a business’s image or brand – such as bad publicity, poor customer service delivery or cybersecurity breaches.
inflationary risk can have serious ramifications for businesses by raising prices or decreasing demand. Furthermore, businesses should keep an eye on market interest rates which could increase or decrease borrowing costs significantly.
People risk (also called staffing risks) is the chance that an organization could experience personnel departure due to more lucrative employment opportunities elsewhere. Proper management of this risk will allow an organization to complete projects on time and meet its strategic goals successfully.
Variations in Risks
Variations in risks can significantly impact risk assessment and management when not addressed adequately. For example, using data sourced arbitrarily from periods with low volatility to estimate value-at-risk estimates could understate both probability of losses occurring and their magnitude significantly. Furthermore, using normal distribution probabilities as the sole basis for risk evaluation underestimates extreme or black swan events by far.
Financial institutions employ VaR calculations to assess the scope and probability of potential losses across individual positions, whole portfolios or entire firms. VaR assessments use either variance-covariance or Monte Carlo methods and can be calculated for specific assets or positions as well as entire firmwide positions. Incremental VaR can be calculated to ascertain whether an additional position should be added or subtracted from an existing portfolio; its precise measurements allow institutions to identify whether concentrations need reducing.
Managing Risks
Risk assessments can be utilized as part of many decision-making processes and often have specific needs and values when designing risk-assessment products. Therefore, their design must balance between meeting these specific demands while still encouraging broad stakeholder participation and deliberation during risk evaluation processes.
This goal can be realized in part by early identification of options to be considered by decision-makers, for instance through problem formulation stages in planning and scoping. Additionally, this stage provides an ideal time for discussing possible sources of uncertainty that might influence these choices and affect formal assessments of decision-centric value in risk assessments. An explicit dialogue regarding any sources of uncertainty also can help avoid the common pitfall of one hazard detracting attention away from another or leading to the unwise substitution (whether informed or uninformed) among concerns.
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