Risk Management V/s Risk Measurement

23/11/2020 0 By indiafreenotes

Risk Management

According to the Marquette University Risk Unit, risk management is the continuing process to identify, analyze, evaluate, and treat loss exposures and monitor risk control and financial resources to mitigate the adverse effects of loss. We typically simplify this a bit and describe it as the Identification, Analysis (or Measurement), Treatment and Monitoring of risk. 

Risk Management is the art, science, process and all the ongoing activities involved in identifying, understanding, assessing, monitoring and then effectively reducing one’s exposure to risks, and the likelihood, impact and undesirable results should any of those risks materialize.

Although risks can be managed, it’s important to appreciate that risks are always evolving (Old risks can metamorphose and change, while new, unfamiliar risks are always emerging) and can never be truly eliminated.

Risk Measurement is the effort to “quantify” the likelihood and potential impact of a given risk or set of risks occurring. It’s just one of the many possible elements of risk assessment.

Measuring risk is generally conducted by using probability and statistical analysis of historic data that conforms to a classic “normal” bell curve distribution. As a result “Standard deviation” is the most common unit now used for risk measurement.

This approach was first articulated by Prof. Frank Knight, in his 1921 book “Risk, Uncertainty, and Profit.” In that book Dr. Knight was the first person to observe that the principal difference between Risk and Uncertainty is that “Risk” can be measured (using statistical methods) and “Uncertainty” cannot be measured. That’s so because the variability of the range of outcomes of uncertain phenomena do not conform to the bell curve distribution model, and by definition cannot measured.

As a result its extremely important to recognize the risk measurement is only reliable when its used in analyzing phenomenon where bell curve distribution patterns are the norm, (outcomes are unknown, but probabilities are known) such as casino gambling, slot machines, lottery, height, weight, and life expectancy.

Attempting to measure risk in areas where uncertainty reigns, (Outcomes are unknown and probabilities are unknown) such as romance, war, earthquakes, business, and investing is flawed & problematic from the very start.