Critique: what caused this crisis

I agree with Anna in her blog “what caused this crisis.” She says that “we have discussed in class that risk management is key to maximizing profits when done correctly.” The news seems to focus on the negative effects of the recession, and what caused them.
With the current economic situation there are numerous companies in the spot light that have practiced bad risk management. However, there are those that have used good risk management receiving no national attention.

Wikipedia defines risk management as assessing, mitigating, and monitoring risks.
Obviously financial companies that have gone bankrupt failed to follow some, if not all, of these steps. In terms of options and derivatives, companies should not rely on making greater bets on riskier bets to make up for their losses. This defeats the purpose of risk management, since you are disregarding the risk associated to try to make up for your losses. Instead, companies should try to make up their losses gradually over time. Doing so, companies will profitable over time and have financial stability.

Anna also states that “risk management is not the problem, it is people and companies that think they can do without risk management or do so much management that they have negative profits.” The point here is, what is the optimal amount of risk management to use. Dong Hyun Ahn from the University of North Carolina states that the optimal amount of risk management you should forego is the amount that minimizes a firm’s value at risk.

We discussed in class that it is too costly to completely hedge your risks, and buying insurance is the most common solution for people and companies to do so. For smaller companies and lower income families insurance may be unaffordable. However, if more people had insurance, the insurance companies could slightly lower premiums by pooling more risk. Thus, the insurance companies would be collecting more money, as well as reducing their risk of incurring large losses.


Links:

http://act-alr.blogspot.com/

http://en.wikipedia.org/wiki/Risk_management

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=225921