Question

Recent events in the financial sector have shown that risk perception plays a critical role in effective risk management. How much influence do you think any one individual should have alone on key risk management decisions eg traders, managers?

Answer 1

For any trader or manager effective risk means to mitigate the risk for the same level of returns. This could only happen by diversifying the portfolio. It means invest in more than one stocks which are less correlated or move in opposite direction.

One individual stock has both systematic and unsystematic risks. Systematic risks is due to market factors like global economic condition etc. But unsystematic risk is attributed to company performance and not the sector performance or macro performance.

Every trader has to manage its risk by seeting the risk tolerance limit. Every manager of the department has the risk tolerance limit. This limit is set by the management. There should be a committee to oversee the risks. in case of traders they should know the risk limit and to control the risks they should set a target which is defined as Stop Loss to mitigate the risks in adverse movements of stocks.

For managers managing the portfolio one should calculate different risk parameters like Value at risk specifying the minimum loss over a certain period of time with desired level of confidence. Thereon he/she calculate the Conditional Value at Risk. That risk parameters should not cross the tolerance limits.

I firmly believe that one individual should be in charge of all the risks borne by him so that effective decisions could be taken by the management.