Risk Managers do not know the Future any Better than Anyone Else

Criticisms of risk managers for not anticipating some emerging future are overdone.  When a major unexpected loss happens, everyone missed it.

Risk managers do not have any special magic ball.  The future is just as dim to us as to everyone else.

Sometimes we forget that.  Our methods seem to be peering into the future.

But that is not really correct.  We are not looking into the future.  Not only do we not know the future, we do not even know the likelihood of various future possibilities, the probability distribution of the future.

That does not make our work a waste of time.  However.

What we should be doing with our models is to write down clearly that view of the future that we use to base our decisions upon.

You see, everyone who makes a decision must have a picture of the future possibilities that they are using to weigh the possibilities and make that decision.  Most people cannot necessarily articulate that picture with any specificity.  Management teams try to make sure that they are all working with similar visions of the future so that the sum of all their decisions makes sense together.

But one of the innovations of the new risk management discipline is to provide a very detailed exposition of that picture of the future.

Unfortunately, many risk managers are caught up in the mechanics of creating the model and they fail to recognize the extreme importance of this aspect of their work.  Risk Managers need to make sure that the future that is in their model IS the future that management wants to use to base their decisions upon.  The Risk Manager needs to understand whether he/she is the leader or the follower in the process of identifying that future vision.

If the leader, then there needs to be an explicit discussion where the other top managers affirm that they agree with the future suggested by the Risk Manager.

If the follower, then the risk manager will first need to say back to the rest of management what they are hearing to make sure that they are all on the same page.  They might still want to present alternate futures, but they need to be prepared to have those visions heavily discounted in decision making.

The Risk Managers who do not understand this process go forward developing their models based upon their best vision of the future and are frustrated when management does not find their models to be very helpful.  Sometimes, the risk manager presents their models as if they DO have some special insight into the future.

My vision of the future is that path will not succeed.

Explore posts in the same categories: Assumptions, Economic Capital, Modeling, Risk Management System


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4 Comments on “Risk Managers do not know the Future any Better than Anyone Else”

  1. […] Do What We Can” would be a good motto for risk managers.  Contrary to popular belief, Risk managers do not know the future any better than anyone else.  But with the twin handicaps of no prescience and popular belief that they possess it, risk […]

  2. […] a read at Risk Managers do not know the Future any Better than Anyone Else. Possibly related posts: (automatically generated)You are not a risk manager; you are a fortune […]

  3. Max Rudolph Says:

    I would suggest going beyond this to critique the scenario(s) used for decision making to say which assumptions are susceptible to driving material differences. The primary scenario is often used to determine incentive compensation, so games like using the forward rates as a best estimate for future interest rates should be placed in the light. It’s too easy to manipulate models for the CRO not to be skeptical.

  4. soniajaspal Says:

    Interesting viewpoint brought forward. The probability of most events occuring is more of a hunch than having reliable past data. Without reliable past data, the forecasting models of risk in future are basically incorrect.

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