Risk Totally Explained

Everything about Risk totally explained

Risk is a concept that denotes a potential negative impact to some characteristic of value that may arise from a future event, or we can say that "Risks are events or conditions that may occur, and whose occurrence, if it does take place, has a harmful or negative effect". Exposure to the consequences of uncertainty constitutes a risk. In everyday usage, risk is often used synonymously with the probability of a known loss. Risk communication and risk perception are essential factors for all human decision making.

Definitions of risk

There are many definitions of risk that vary by specific application and situational context. Risk is described both qualitatively and quantitatively.
Qualitatively, risk is proportional to both the expected losses which may be caused by an event and to the probability of this event. Greater loss and greater event likelihood result in a greater overall risk.
Frequently in the subject matter literature, risk is defined in pseudo-formal forms where the components of the definition are vague and ill-defined, for example, risk is considered as an indicator of, or depends on threats, vulnerability, impact and uncertainty.
In engineering, the definition of risk is:
ť

Risk = ) 	imes C

The total risk is then the sum of the individual class-risks.
In the nuclear industry, consequence is often measured in terms of off-site radiological release, and this is often banded into five or six decade-wide bands.
.

Operational risk

Safety engineering The risks are evaluated using fault tree/event tree techniques (see safety engineering). Where these risks are low, they're normally considered to be "Broadly Acceptable". A higher level of risk (typically up to 10 to 100 times what is considered Broadly Acceptable) has to be justified against the costs of reducing it further and the possible benefits that make it tolerable—these risks are described as "Tolerable if ALARP". Risks beyond this level are classified as "Intolerable".
The level of risk deemed Broadly Acceptable has been considered by regulatory bodies in various countries—an early attempt by UK government regulator and academic F. R. Farmer used the example of hill-walking and similar activities which have definable risks that people appear to find acceptable. This resulted in the so-called Farmer Curve of acceptable probability of an event versus its consequence.
The technique as a whole is usually referred to as Probabilistic Risk Assessment (PRA) (or Probabilistic Safety Assessment, PSA). See WASH-1400 for an example of this approach.

In finance

In finance, risk is the probability that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. It is usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment.
In finance, risk has no one definition, but some theorists, notably Ron Dembo, have defined quite general methods to assess risk as an expected after-the-fact level of regret. Such methods have been uniquely successful in limiting interest rate risk in financial markets. Financial markets are considered to be a proving ground for general methods of risk assessment.
   However, these methods are also hard to understand. The mathematical difficulties interfere with other social goods such as disclosure, valuation and transparency. In particular, it's often difficult to tell if such financial instruments are "hedging" (purchasing/selling a financial instrument specifically to reduce or cancel out the risk in another investment) or "gambling" (increasing measurable risk and exposing the investor to catastrophic loss in pursuit of very high windfalls that increase expected value).
   As regret measures rarely reflect actual human risk-aversion, it's difficult to determine if the outcomes of such transactions will be satisfactory. Risk seeking describes an individual whose utility function's second derivative is positive. Such an individual would willingly (actually pay a premium to) assume all risk in the economy and is hence not likely to exist.
   In financial markets, one may need to measure credit risk, information timing and source risk, probability model risk, and legal risk if there are regulatory or civil actions taken as a result of some "investor's regret".
   "A fundamental idea in finance is the relationship between risk and return. The greater the amount of risk that an investor is willing to take on, the greater the potential return. The reason for this is that investors need to be compensated for taking on additional risk."
   "For example, a US Treasury bond is considered to be one of the safest investments and, when compared to a corporate bond, provides a lower rate of return. The reason for this is that a corporation is much more likely to go bankrupt than the U.S. government. Because the risk of investing in a corporate bond is higher, investors are offered a higher rate of return."

In public works

In a peer reviewed study of risk in public works projects located in twenty nations on five continents, Flyvbjerg, Holm, and Buhl (2002, 2005) documented high risks for such ventures for both costs (External Link

) and demand (External Link

). Actual costs of projects were typically higher than estimated costs; cost overruns of 50% were common, overruns above 100% not uncommon. Actual demand was often lower than estimated; demand shortfalls of 25% were common, of 50% not uncommon.
Due to such cost and demand risks, cost-benefit analyses of public works projects have proved to be highly uncertain.
The main causes of cost and demand risks were found to be optimism bias and strategic misrepresentation. Measures identified to mitigate this type of risk are better governance through incentive alignment and the use of reference class forecasting (External Link

Risk in psychology

Regret

In decision theory, regret (and anticipation of regret) can play a significant part in decision-making, distinct from risk aversion (preferring the status quo in case one becomes worse off).

Framing

Framing(Tversky, Amos, and Daniel Kahneman, 1981. "The Framing of Decisions and the Psychology of Choice.") is a fundamental problem with all forms of risk assessment. In particular, because of bounded rationality (our brains get overloaded, so we take mental shortcuts), the risk of extreme events is discounted because the probability is too low to evaluate intuitively. As an example, one of the leading causes of death is road accidents caused by drunk driving—partly because any given driver frames the problem by largely or totally ignoring the risk of a serious or fatal accident.
For instance, an extremely disturbing event (an attack by hijacking, or moral hazards) may be ignored in analysis despite the fact it has occurred and has a nonzero probability. Or, an event that everyone agrees is inevitable may be ruled out of analysis due to greed or an unwillingness to admit that it's believed to be inevitable. These human tendencies to error and wishful thinking often affect even the most rigorous applications of the scientific method and are a major concern of the philosophy of science.
All decision-making under uncertainty must consider cognitive bias, cultural bias, and notational bias: No group of people assessing risk is immune to "groupthink": acceptance of obviously wrong answers simply because it's socially painful to disagree, where there's conflicts of interest. One effective way to solve framing problems in risk assessment or measurement (although some argue that risk can't be measured, only assessed) is to raise others' fears or personal ideals by way of completeness.

Fear as intuitive risk assessment

For the time being, people rely on their fear and hesitation to keep them out of the most profoundly unknown circumstances.
   In The Gift of Fear, Gavin de Becker argues that "True fear is a gift. It is a survival signal that sounds only in the presence of danger. Yet unwarranted fear has assumed a power over us that it holds over no other creature on Earth. It need not be this way."
   Risk could be said to be the way we collectively measure and share this "true fear"—a fusion of rational doubt, irrational fear, and a set of unquantified biases from our own experience.
   The field of behavioral finance focuses on human risk-aversion, asymmetric regret, and other ways that human financial behavior varies from what analysts call "rational". Risk in that case is the degree of uncertainty associated with a return on an asset.
   Recognizing and respecting the irrational influences on human decision making may do much to reduce disasters caused by naive risk assessments that pretend to rationality but in fact merely fuse many shared biases together.

Root causes of risk

Optimism bias and strategic misrepresentation have been found to be root causes of risk.

Risk assessment and management

Because planned actions are subject to large cost and benefit risks, proper risk assessment and risk management for such actions are crucial to making them successful (Flyvbjerg 2006).
Since Risk assessment and management is essential in security management, both are tightly related. Security assessment methodologies like BEATO or CRAMM contain risk assessment modules as an important part of the first steps of the methodology. On the other hand, Risk Assessment methodologies, like Mehari evolved to become Security Assessment methodologies.

Risk in auditing

The audit risk model expresses the risk of an auditor providing an inappropriate opinion of a commercial entity's financial statements. It can be analytically expressed as:
ť AR = IR x CR x DR

Where AR is audit risk, IR is inherent risk, CR is control risk and DR is detection risk.

Categories of risks

Political: Change of government, cross cutting policy decisions (for example, the Euro).

Professional: Associated with the nature of each profession.

Economic: Ability to attract and retain staff in the labour market; exchange rates affect costs of international transactions; effect of global economy on UK economy.

Socio-cultural: Demographic change affects demand for services; stakeholder expectations change.

Health and Safety: Buildings, vehicles, equipment, fire, noise, vibration, asbestos, chemical and biological hazards, food safety, traffic management, stress, lone working, etc.

Technological: Obsolescence of current systems; cost of procuring best technology available, opportunity arising from technological development.

Contractual: Associated with the failure of contractors to deliver devices or products to the agreed cost and specification.

Environmental: Buildings need to comply with changing standards; disposal of rubbish and surplus equipment needs to comply with changing standards.

Physical: Theft, vandalism, arson, building related risks, Storm, flood, other related weather, damage to vehicles, mobile plant and equipment.

Operational: Relating to existing operations – both current delivery and building and maintaining.Further Information

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