State-of-the-Art Research in Enterprise Risk Management Desheng

State-of-the-Art Research in Enterprise Risk Management • Desheng Dash WU • Dash@risklab. ca

Outline • Why, What, How – 3 step process • Tool • Our model • Conclusion

Step-by-step Risk Management Confucius (551 B. C. – 479 B. C. ) self-cultivating; family-regulating; state-harmonizing; William Shakespeare: The man very probable (land governed. ) 4

Risk view of Economic family-regulating 6

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ERM Natural Disasters “把我空投进去！”

Risk management Definition

Enterprise risk management (ERM) What • Systematic, integrated approach – Manage all risks facing organization – Concerned with a broad financial and operating perspective – Recognizes interdependencies corporate, financial, and environmental factors • COSO ERM "…process, effected by an entity's board of directors, management, and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives. "

Outline • Why, What, How – 3 step process • Tool • Our model • Conclusion

Analytic Risk Management Tools • Duration • Markowitz mean-variance 1938 1952 – perfect capital markets, log-normally distributed • Sharpe’s CAPM 1964 – perfect capital markets, log-normally distributed • • Multiple factor models Black-Merton-Scholes model RAROC (Bank Trust) Limits by duration buckets 1966 1973 1986

Analytic Risk Management Tools • • Risk-weighted assets (banks) Stress Testing Value-at-Risk, Va. R Risk. Metrics Credit. Metrics Integration of credit and market Enterprise RM (Refer to Olson and Wu, 2007) 1988 1992 1993 1994 1997 19982000 -

Finance: market risk Olson & Wu, Springer book 2010

Finance: Credit risk Olson & Wu, Springer book 2010

March 2013. ERM Committee of the American Academy of Actuaries. Insurance Enterprise Risk Management Practices

Keep ATM : ERM Strategy how Olson & Wu, Springer book 2010 – Risk Keep • Top management， CRO • Appetite – Risk Avoid – Risk Transfer – Risk Mitigate

Outline • Why, What, How – 3 step process • Tool • Our model • Conclusion

Top. Aimer: ERM Decision Support how Olson & Wu, Springer book 2010 – Risk Appetite • Top management，CRO • Risk culture, organization, governance • Hydro. One: a risk management team from top level – Risk Identification • Market, credit, operations – Risk Matrix • Va. R – Risk Enumeration • algorithm – Risk Review • audit

Top. Aimer: Uncertain Optimization Model Minimize f ( x, z ) Minimize a 1 x 1 + a 2 x 2 + … + anxn Subject To: g 1( x, z ) ≤ b 1 g 2( x, z ) ≤ b 2 … Subject To: a 11 x 1 + a 12 x 2 + … + a 1 nxn ≤ b 1 a 21 x 1 + a 22 x 2 + … + a 2 nxn ≤ b 2 … g m( x, z ) ≤ bm am 1 x 1 + am 2 x 2 + … + amnxn ≤ bm Decision Variables x Uncertain Params z Decision Variables x All aij depend on uncertain z

Hydro One Example – Harvard business review case Jul 03, 2008; Electricity Price in Year 1 also in Wu and Olson, 2009 Buy Ele and Resell Immediately Demand in Year 1 Buy Ele contract and Store for Next Year Electricity Price in Year 2 Storage Cost Buy Ele and Resell in Year 2 Demand in Year 2 • Case 1: Make All Three Decisions Today • Case 2: Make 3 rd Decision on ‘Wait and See’ Basis

Top. Aimer: based on Excel Risk. Solver

Conclusions • Risky world • Risk unavoidable • Integration: ERM • ERM new philosophy of RM