Behavioural Risk Management: Closing Thoughts

Behavioural economics and all its derivatives have gained importance in academia over the last few decades. Economists such as Thaler have gradually come to the conclusion that the adjective “behavioural” should be dropped: by now, economics as a science should embrace human behaviour along with all its irrationality. Risk management as a profession (not necessarily a science) has developed roughly during the same timeframe, but has focused on traditional economic theories. Stochastic techniques have become the cornerstone of both the risk management practice and regulatory methodologies. VaR has become the only central risk measure, with some variants being derived from the same principle, such as earnings-at-risk. The regulatory focus on VaR has further supported this convergence, leading to a certain myopic effect. Those risk managers that included other risk management techniques, such as maximum loss or scenario techniques, have come a long way in convincing their colleagues and the decision-makers around them. Figure 14.1 shows how VaR relates to other techniques in the risk management toolkit in relation to the problems that need to be addressed. The figure illustrates why