Enhancing risk management for an aging world

As the world confronts unprecedented global aging, academics and policymakers are growing increasingly aware of the need for better risk management tools to handle the demographic transition. It is therefore imperative to identify innovative insurance and financial market products that can enrich the range of options for households, firms, and governments facing the challenge of an aging population. After outlining thoughts on how rising longevity might shape financial markets, we discuss opportunities for the finance and insurance industries in this arena. We also highlight how policymakers could respond to improve efforts to better manage risk.     

Managing demographic risk

In developed nations, the workforce is aging rapidly. That trend has serious implications. Companies could face severe labor shortages in a few years as workers retire, taking critical knowledge with them. Businesses may also see productivity decline among older employees, especially in physically demanding jobs. The authors, partners at Boston Consulting Group, offer managers a systematic way to assess these dual threats--capacity risk and productivity risk--at their companies. It involves studying the age distribution of their employees to see if large percentages fall within high age brackets and then projecting--by location, unit, and job category--how the distribution will change over the next 15 years. Managers must also factor in both the impact of strategic moves on personnel needs and the future supply of workers in the market. When RWE Power analyzed its trends, the company learned that in 2018 almost 80% of its workers would be over 50. What's more, in certain critical areas its labor surplus was about to become a sizable shortfall. For instance, a shortage of specialized engineers would develop in the company just as their ranks in the job market thinned and competition to hire them intensified. Reversing its downsizing course, RWE Power took steps to increase its supply of workers in those key positions. The authors show how companies that face talent gaps, as RWE Power did, can close them through training, transfers, recruitment, retention, productivity improvements, and outsourcing. They also describe measures that companies can take to keep older workers productive, including workplace accommodations, revised compensation structures, performance incentives, and targeted health care management. The key is to identify and address potential problems early. Firms that do so will gain an edge on rivals that are still relentlessly focused on reducing head count.     

The world ex ante risk premium: an empirical investigation

A number of recent papers have focused on testing the linearity restrictions implied by international asset pricing models. The tests, however, have not addressed an additional restriction implied by the models; namely, that the risk premium on the world portfolio is positive. This study provides a direct assessment of this restriction. The evidence indicates that the ex ante world market risk premium can be negative. The results are robust to market proxies that are hedged and unhedged with respect to currency risk. Subperiod analysis indicates that the rejection of the positive risk premium restriction is driven by the first half of the sample period.     

Managing unintentional dwelling fire risk

In this paper, we examine the management of unintentional dwelling fire risk through the development of a geographical information system (GIS) for dwelling fire prevention support based upon an 18-month case study in a UK fire and rescue service. Previous research into causal factors in unintentional dwelling fire incidents was used to guide the development of a multiple linear regression risk model for dwelling fire incidents that was the basis of the GIS developed. The GIS provided a more detailed analysis of unintentional dwelling fire risk factors, and enabled more targeted fire prevention activities for the identified at-risk social groups.     

Managing in an age of modularity

Modularity is a familiar principle in the computer industry. Different companies can independently design and produce components, suck as disk drives or operating software, and those modules will fit together into a complex and smoothly functioning product because the module makers obey a given set of design rules. Modularity in manufacturing is already common in many companies. But now a number of them are beginning to extend the approach into the design of their products and services. Modularity in design should tremendously boost the rate of innovation in many industries as it did in the computer industry. As businesses as diverse as auto manufacturing and financial services move toward modular designs, the authors say, competitive dynamics will change enormously. No longer will assemblers control the final product: suppliers of key modules will gain leverage and even take on responsibility for design rules. Companies will compete either by specifying the dominant design rules (as Microsoft does) or by producing excellent modules (as disk drive maker Quantum does). Leaders in a modular industry will control less, so they will have to watch the competitive environment closely for opportunities to link up with other module makers. They will also need to know more: engineering details that seemed trivial at the corporate level may now play a large part in strategic decisions. Leaders will also become knowledge managers internally because they will need to coordinate the efforts of development groups in order to keep them focused on the modular strategies the company is pursuing.     

The world price of liquidity risk

This paper empirically tests the liquidity-adjusted capital asset pricing model of Acharya and Pedersen (2005) on a global level. Consistent with the model, I find evidence that liquidity risks are priced independently of market risk in international financial markets. That is, a security’s required rate of return depends on the covariance of its own liquidity with aggregate local market liquidity, as well as the covariance of its own liquidity with local and global market returns. I also show that the US market is an important driving force of global liquidity risk. Furthermore, I find that the pricing of liquidity risk varies across countries according to geographic, economic, and political environments. The findings show that the systematic dimension of liquidity provides implications for international portfolio diversification.     

中国信保重新认定全球国家风险

前不久，由中国出口信用保险公司推出的《国家风险分析报告》（2007年版）显示：与2005～2006年相比，我国企业所面临的全球整体风险水平呈现下降趋势，其中新兴市场国家和地区如俄罗斯、中东欧和非洲地区的风险水平整体向好趋势明显。与此同时，部分国家则暴露出新的风险信号。数据显示，全球有近3成国家对我国企业的国家风险水平显著上升，其中以玻利维亚、斯里兰卡、黎巴嫩、伊朗等国的国家风险上升为最，均上升到第8级，步入国家风险水平显著之列。     

Managing risk through the veil of ignorance

Background. We view overconfidence within risk management as a problem likely to manifest within philosophical preferences for anticipationism over resilienism, and in assumptions that risks are objectively real external powers or potentialities rather than subjective knowledge propositions. Methods. We argue that the realist tradition within Italian social theory, first crystallised by Niccolò Machiavelli and later elaborated by the sociologist Vilfredo Pareto, offers valuable lessons for corporate risk management praxis by demanding that we map out the complex relations between the risk subjectivities of risk managers, and their objective risk environments, from a standpoint of psychological and sociological realism which stresses the risk ignorance of practitioners. We caution that risk management efforts to improve risk subjectivities to achieve perfect veridicality to objective risk environments might often amount to a wishful bildungsroman of epistemological growth, reflecting the common aspirations of risk managers to demonstrate professional competence. We suggest that the profession should control this overconfidence problem by stressing the corrigibility of risk subjectivities with reference to sociological understandings that reflect on the widespread risk ignorance that can persist and even intensify where risk management effort is made. Results. Following the macrosociological framework sketched by Pareto, we show how two common ‘modes of uncertainty’ can be scrutinised for their adaptive fitness to two common types of risk environment. Conclusions. It can be helpful to think sociologically of organisations as engaging with some highly significant strategic risks blindly through a veil of ignorance.     

The world price of sentiment risk

This paper examines whether sentiment can be considered a priced source of risk on international financial markets. We investigate whether residual sentiment is rewarded with a risk premium if added to a model with macroeconomic fundamentals and analyze the time-variation of the respective risk premia. The analysis is performed in the framework of a conditional multiple-beta pricing model and focusses on the excess returns of the G7 stock markets in the period from February 1999 to February 2012. The obtained results indicate that sentiment indeed earns a significant risk premium of around 2% p.a. on the considered markets.     

Beyond the contract: Managing risk in supply chain relations

As a consequence of the development of intensified relations with suppliers, for many firms the supply chain has become a significant source of risk exposure. In this paper we examine firms’ use of control practices to manage risks associated with intensified collaboration with supply chain partners. Specifically, we examine how buyers manage risks associated with interfirm transactions through their choice of supply partner, in terms of perceived goodwill and competence trust, and their use of multiple interrelated supply chain management (SCM) control practices. These control practices include contractual contingency planning, performance target setting, operational reviews, information sharing, supplier support and joint problem solving. We collect survey data from Japanese manufacturing firms about their relations with part suppliers to test hypotheses about the associations between transaction risks, selection of trusted suppliers and use of SCM practices. Our results support that transaction characteristics that are at the basis of transaction risks significantly affect the selection of trusted partners to collaborate with as well as their use of various control practices to manage relationships. We also find that in particular competence trust facilitates the use of control practices to support effective SCM.     

Managing ethical risk: How investing in ethics adds value

In September 1999, the University of Notre Dame hosted a conference entitled “Measuring and Managing Ethical Risk: How Investing in Ethics Adds Value”. The motivations for hosting the conference and the papers presented there are summarized. Several themes that are present in the papers are discussed. These include the gains from combining the anthropological approach to business ethics with the neoclassical economics approach, the central role of trust in business ethics, the role of ethics in the corporation, and the function of the legal system in setting and enforcing ethical standards for the financial system.     

Liquidity and valuation in an uncertain world

During the 2007–2009 financial crisis there was little or no trading in a variety of financial assets, even though bid and ask prices existed for many of these assets. We develop a model in which this illiquidity arises from uncertainty, and we argue that this new form of illiquidity makes bid and ask prices unsuitable as metrics for establishing “fair value” for these assets. We show how the extreme uncertainty that traders face can be characterized by incomplete preferences over portfolios, and we use Bewley's (2002) model of decision making under uncertainty to derive equilibrium quotes and the nonexistence of trading at these quotes. We then suggest alternatives for valuing assets in illiquid markets.     

The world price of jump and volatility risk

We study international integration of markets for jump and volatility risk, using index option data for the main global markets. To explain the cross-section of expected option returns we focus on return-based multi-factor models. For each market separately, we provide evidence that volatility and jump risk are priced risk factors. There is little evidence, however, of global unconditional pricing of these risks. We show that UK and US option markets have become increasingly interrelated, and using conditional pricing models generates some evidence of international pricing. Finally, the benefits of diversifying jump and volatility risk internationally are substantial, but declining.     

Liquidity risk and stock returns around the world

The recent global financial crisis demonstrates that market liquidity is a prominent systematic risk globally. We find that local liquidity risk, in addition to the local market, value and size factors, demands a systematic premium across stocks in 11 developed markets. This local pricing premium is smaller in countries where the country-level corporate boards are more effective and where there are less insider trading activities. We also discover that global liquidity risk is a significant pricing factor across all developed country market portfolios after controlling for global market, value, and size factors. The contribution of this risk to the return on a country market portfolio is economically and statistically significant within and across regions.     

Managing risk in a poor economy: The association between economic activity and auditor response to risk

We examine the association between economic climate and auditor risk acceptance as measured by the auditors' reaction to internal control weaknesses. We hypothesize and find that auditors address risk in a way that is conditioned on the economic environment. In particular, we find that during periods of weak economic activity, auditors tend to assess lower risk premiums and are less likely to resign in response to an adverse ICFR opinion. However, we find evidence that economic factors do not influence fees assessed by incoming auditors following a resignation in the presence of an ICFR weakness. Our results indicate that auditors modify their engagement risk strategies during challenging economic times and accept higher levels of risk to attract and retain clients. For the riskiest clients, however, economic factors do not appear to influence auditors' risk pricing.     

Managing perceived risk for credit card purchase through supplementary services

The present study aims to understand the significance of supplementary services as nonpersonal sources of information to consumers to handle perceived risk associated with the purchase of credit card services. The impact of supplementary services is particularly studied towards functional risk and psychological risk. The study is based on primary data collected by a survey with the help of a questionnaire administered through personal interviews. It is found that supplementary services can play a significant role in controlling functional and psychological perceived risk associated with credit card services. Marketers of credit cards can enhance the value of services to customers and can thus enhance purchase possibilities by reducing perceived risk through supplementary services that are controllable. Perceived risk in financial services marketing is an important factor from the consumers’ point of view for purchase decisions and is also an issue of significance to service marketers. It is an original attempt to examine the relationship between perceived risk and supplementary services.