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Alternative Market Briefing

Risk Management in 2020: How gut feelings sniffed out what math couldn't

Wednesday, September 09, 2020

Bailey McCann, Opalesque New York:

Risk managers are supposed to rely on hard data, but what happens when a gut feeling is more accurate? A new note from consultants at Capital Market Risk Advisors (CMRA) suggests that one of the big lessons of the covid era is that risk managers should follow their hunches even if the data hasn't caught up yet.

Interviews with risk managers conducted by CMRA suggest that while markets were aware of a potential threat from the coronavirus in January, few risk models took it seriously. The threat was vague and hard to quantify, which meant risk managers put off doing stress tests that considered its potential impact until it was almost too late.

"If risk management only proposes hedging likely risks, then risk management becomes another part of investment management," the note says. "The whole point of risk management is to specialize in the unlikely and high-impact risks, not the likely ones. Investment management and trading, in contrast, specializes in high-probability, low-impact situations. The risk of Covid-19 was tough to quantify. But risk management must not rely exclusively on science-based, mathematical loss calculations. It must also rely on gut instincts and judgments."

The pandemic also highlighted how risk management needs to adapt in its response to an extreme event. It's not enough to include updated volatility in models, instead, risk managers should be stress testing every day until markets return to......................

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