Law of Risk & Light

Risk management is all about making conscious decisions about risk taking.  Fully recognizing the potential losses that could result from a risky undertaking.  But in many camps, risk management is being simplified and simplified to a point where it may well mislead CEOs and Boards about the potential effectiveness of an oversimplified risk management regime.

These simplified risk management regimes are often in violation of the Law.  The Law of Risk and Light…

Risks in the light shrink, Risks in the dark grow
Return for Risks in the light shrinks faster than risk
Return for Risks in the dark does not grow as fast as risk

What this means is that risks that are visible to the market (in the light) will be managed by the market. The degree of uncertainty around the risk will shrink. With decreased uncertainty, the risk premium will shrink. With broad comfort, demand will rise; with increased demand, risk premium will shrink further.

Risks in the dark are risks that are not visible or known to the market. If the market charges little or nothing for a risk, then those who are aware of the risk will bring more and more of that risk to market. And if the market continues to be unaware of a risk, then more and more extreme versions of the risk will be brought to market, the risk will grow.
As the risks grow and grow, that growth might be noticed faintly by the market as a shadow of a risk. Some market participants are canny enough to know that if someone really wants to do a transaction, then a higher price for that transaction is probably in order, even if they do not fully understand the underlying reasons.

This law is as fundamental to risk management as supply and demand is fundamental to micro economics.  Any risk management actions that are taken or planned without recognition of the risks that may be in the dark initially could end up to be as flawed as management without consideration of risk.

Risk & Light was the winner of the Practical Paper Award at the 2009 Enterprise Risk Management Symposium

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12 Comments on “Law of Risk & Light”


  1. […] “Risk and Light” or “The Law of Risk and […]


  2. […] target.  (for discussion of the flaw in the idea of “one number” management, see Risk and Light.)   But the reason why setting the required capital at that high of a level is that it then leaves […]


  3. […] Law of Risk and Light applies to these aspects of risk management just as it applies to aspects of risk.  The risk […]


  4. […] Martin and Power go on to suggest that ERM that uses just one risk measure (usually VAR) is difficult to get right because of limitations of VAR.  RISKVIEWS would add that an ERM program that uses only one risk measure, no matter what that measure is, will be prone to problems.  See Law of Risk and Light.  […]


  5. […] firm that makes its money taking risks should never rely upon a single measure of risk.  See Risk and Light and the CARE Report for further […]


  6. […] they were recording on their risk taking were risk premiums for taking very large risks that were “in the dark“.  According to Taleb, they were being massively underpaid for those large but infrequent […]


  7. […] that if you really, really concentrate on measuring risk that you will get it right. But the Law of Risk and Light tells us that our risk taking systems will lead us to avoid the risk in the light and to load up on […]


  8. […] The idea of Latent Risks is also important for existing ERM programs.  That is because the world keeps changing and firms will develop new risks and risks that they did identify earlier but dismissed as insignificant have now grown.  And those Latent Risks are the risks that are most likely to grow.  (see Risk & Light) […]


  9. […] If you keep it simple and focused and identify the ONE MOST IMPORTANT RISK METRIC and focus all of your risk management systems around controlling risk as defined by that one metric, you will eventually end up accumulating more and more of some risk that fails to register under that metric.  See Risk and Light. […]


  10. […] second effect is what I call the Law of Risk and Light.  That says that you will accumulate risks wherever you are not looking out for them.  So […]

  11. riskviews Says:

    A summary of the Risk and Light paper was published in Contingencies.
    http://www.contingenciesonline.com/contingenciesonline/20090910/?pg=92


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