The Five F’s of Risk

Most people have heard of the human reflex when threatened:

Fight or Flee

But in fact, studies show that the most common reaction is:

Freeze

There are two additional reflexive reactions after an adverse event that have a big impact in Risk Management:

Forgive and Forget

“War does not determine who is right – only who is left.” — George Bernard Shaw

Risk Managers can start at the end of that list.

Forgetting can be part of an unhealthy process of putting the past behind us without dealing with or learning from it.  One important task for the risk manager is to make sure that the organization forms appropriate memories of adverse events.

Organizations can be too forgiving or too punitive.  Being too forgiving sends the wrong message.   It gives the message that there are no consequences.  Being too punitive puts a scare on folks so that they will fear to take any risk.  It is best if management can have some ideas of possible responses to problems before they happen.  That way, they can communicate their intentions, so that employees are aware of the types of things that do have serious consequences and the sorts that will be quickly forgiven.

One of the main benefits of organized risk management is that it has the potential to reduce the degree to which people will freeze in the face of a crisis.  The freeze reflex is the brain waiting for the memory to find a pattern that can be applied to the current situation.  If the problem is truly a Black Swan or Unknown Unknown, then there is no pattern in memory.  One objective of risk management it to create a bank of such patterns so that when the BS/UU happens, the brain finds something and does not go into an infinite loop, commonly known as freezing in place.

Risk Management is also supposed to be able to inform the Fight or Flee choice.  Risk management for trading desks was invented for exactly that purpose.  The people who were the best traders have a very high tendency towards fighting.  In their world, the heroes are the people who never flee in the face of adverse market trends.  They always know when they are right and the market is temporarily wrong and hold their ground until the market gets it head on straight.  Risk managers are supposed to be able to step in and ring the bell that says that it is time to take your losses and FLEE the position, before it loses $6 Billion or then entire firm as it has several places.

So there it is.  The Five F’s of Risk.

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