Question

Diversification is a useful technique for handling speculative risk, but it cannot be used to handle pure risk effectively and

From the viewpoint of a proponent of ERM, explain why the traditional 'silo' approach to corporate risk management is flawed.

Answer 1

Speculative Risk and diversification

Speculative risk is a type of risk that, when performed, results in an unpredictable amount of benefit or loss. Both speculative risks are made as deliberate decisions and are not merely the product of uncontrollable circumstances. Because there is a probability of either gain or loss, the optimistic risk is the reverse of pure risk, which is the likelihood of nothing but loss with no hope for gain.

Diversification eliminates risk by investing in portfolios covering various financial instruments, markets and other categories.

Diversification helps to manage the speculative risk in the following ways -

Risk Reduction

Risk sharing

Risk transfer

Silo Approach

Risk Silo is an implicit function delegated to risk management operational frameworks. It demonstrate that treating the variety of potential risks in isolation rather than as a whole The approaches to risk management Silo (but with varying levels of adoption/ success) have been developed to discuss more comprehensive risk management operational structures called Enterprise broad risks management, Adaptive Risk Management and Strategic Risk Management.

• Risk silos may hinder efforts for Risk Aggregation, that is collecting and compiling a complete overview of exposure to certain risks.
• Silo approach management of risks can result in a number of other issues, such as the duplication of risk reduction activities, the lack of a mechanism for risk analysis, and the absence of a cross-organization exchange of risk information.
• All of these challenges make identifying and handling the key risks that an enterprise faces incredibly complicated. While businesses can work in independent business units, one specific risk can influence several multiple components of the company
• Risk managers understand how changes needs to be made; they can be challenged by other managers, particularly if, in a siloed risk management approach, the business has flourished.