Question

Financial risk management models are only as good as the data that are used in the models. Identify three potential problems with data used in the models and how these problems could be mitigated.

Answer 1

A very important area of financial risk management is systemic risk modelling, which concerns the estimation of the interrelationships between financial institutions, with the aim of establishing which of them are more central and, therefore, more contagious/subject to contagion. A model that, differently from existing ones, employs not only the information contained in financial market prices, but also big data coming from financial tweets. From a methodological viewpoint, the novelty of our paper is the estimation of systemic risk models using two different data sources: financial markets and financial tweets, and a proposal to combine them, using a Bayesian approach. From an applied viewpoint, the first systemic risk model based on big data, and show that such a model can shed further light on the interrelationships between financial institutions. The ultimate purpose of risk identification and analysis is to prepare for risk mitigation. Mitigation includes reduction of the likelihood that a risk event will occur and/or reduction of the effect of a risk event if it does occur.

Risk management planning needs to be an ongoing effort that cannot stop after a qualitative risk assessment, or a Monte Carlo simulation, or the setting of contingency levels. Risk management includes front-end planning of how major risks will be mitigated and managed once identified. Therefore, risk mitigation strategies and specific action plans should be incorporated in the project execution plan, or risk analyses are just so much wallpaper. Risk mitigation plans should

• Characterize the root causes of risks that have been identified and quantified in earlier phases of the risk management process.

• Evaluate risk interactions and common causes.

• Identify alternative mitigation strategies, methods, and tools for each major risk.

• Assess and prioritize mitigation alternatives.

• Select and commit the resources required for specific risk mitigation alternatives.