state-of-the-art research in enterprise risk management desheng dash wu dash@risklab.ca

State-of-the-Art Research in

Enterprise Risk Management

• Desheng Dash WU• Dash@risklab.ca

Outline

• Why, What, How – 3 step process

• Tool

• Our model

• Conclusion

4

self-cultivating;

family-regulating;

state-harmonizing;

(land governed.)

Step-by-step Risk Management

Confucius (551 B.C. – 479 B.C.)

William Shakespeare: The man very probable

6

Risk view of Economic family- family-regulating

7/26

ERM Natural Disasters“把我空投进去！”

Risk management Definition

• Systematic, integrated approach– Manage all risks facing organization– Concerned with a broad financial and operating

perspective– Recognizes interdependencies corporate, financial,

and environmental factors

• COSO ERM "…process, effected by an entity's board of directors, management, and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives."

Enterprise risk management (ERM)What

Outline

• Why, What, How – 3 step process

• Tool

• Our model

• Conclusion

Analytic Risk Management Tools

• Duration 1938• Markowitz mean-variance 1952

– perfect capital markets, log-normally distributed

• Sharpe’s CAPM 1964– perfect capital markets, log-normally distributed

• Multiple factor models 1966• Black-Merton-Scholes model 1973• RAROC (Bank Trust) 1983• Limits by duration buckets 1986

Analytic Risk Management Tools

• Risk-weighted assets (banks) 1988

• Stress Testing 1992

• Value-at-Risk, VaR 1993

• RiskMetrics 1994

• CreditMetrics 1997

• Integration of credit and market 1998-

• Enterprise RM 2000- (Refer to Olson and Wu, 2007)

Olson & Wu, Springer book 2010

Finance: market risk

Olson & Wu, Springer book 2010

Finance: Credit risk

March 2013. ERM Committee of the American Academy of Actuaries. Insurance Enterprise Risk Management Practices

Olson & Wu, Springer book 2010

– Risk Keep• Top management ， CRO• Appetite

– Risk Avoid

– Risk Transfer

– Risk Mitigate

Keep ATM : ERM Strategy how

Outline

• Why, What, How – 3 step process

• Tool

• Our model

• Conclusion

Olson & Wu, Springer book 2010

– Risk Appetite• Top management ， CRO• Risk culture, organization, governance• HydroOne: a risk management team from top level

– Risk Identification• Market, credit, operations

– Risk Matrix• VaR

– Risk Enumeration• algorithm

– Risk Review• audit

TopAimer: ERM Decision Supporthow

TopAimer: Uncertain Optimization Model

Minimize f ( x, z )

Subject To: g 1( x, z ) ≤ b1

g 2( x, z ) ≤ b2

…

g m( x, z ) ≤ bm

DecisionVariables x

Minimize a1x1 + a2x2 + … + anxn

Subject To: a11x1 + a12x2 + … + a1nxn ≤ b1

a21x1 + a22x2 + … + a2nxn ≤ b2 …

am1x1 + am2x2 + … + amnxn ≤ bm

DecisionVariables x

UncertainParams z

All aij depend on uncertain z

Hydro One Example – Harvard business review case Jul 03, 2008;

also in Wu and Olson, 2009

Buy Ele and Resell Immediately

Buy Ele contract and Store for Next Year

Buy Ele and Resell in Year 2

Demandin Year 1

Demandin Year 2

Storage Cost

• Case 1: Make All Three Decisions Today• Case 2: Make 3rd Decision on ‘Wait and See’ Basis

Electricity Pricein Year 2

Electricity Pricein Year 1

TopAimer: based on Excel RiskSolver

Conclusions

• Risky world• Risk unavoidable• Integration: ERM

• ERM new philosophy of RM