State-of-the-Art Research in Enterprise Risk Management

1. State-of-the-Art Research in Enterprise Risk Management • Desheng Dash WU • Dash@risklab.ca

3. Outline Why, What, How – 3 step process Tool Our model Conclusion

4. Step-by-step Risk ManagementConfucius (551 B.C. – 479 B.C.) self-cultivating; family-regulating; state-harmonizing; (land governed.) • William Shakespeare: • The man very probable 4

5. Risk view of Economic family-family-regulating 6

6. 7/26

7. ERM Natural Disasters“把我空投进去！”

8. Risk management Definition

9. Systematic, integrated approach Manage all risks facing organization Concerned with a broad financial and operating perspective Recognizes interdependencies corporate, financial, and environmental factors COSO ERM "…process, effected by an entity's board of directors, management, and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives." Enterprise risk management (ERM)What

10. Outline Why, What, How – 3 step process Tool Our model Conclusion

11. Analytic Risk Management Tools Duration 1938 Markowitz mean-variance 1952 perfect capital markets, log-normally distributed Sharpe’s CAPM 1964 perfect capital markets, log-normally distributed Multiple factor models 1966 Black-Merton-Scholes model 1973 RAROC (Bank Trust) 1983 Limits by duration buckets 1986

12. Analytic Risk Management Tools Risk-weighted assets (banks) 1988 Stress Testing 1992 Value-at-Risk, VaR 1993 RiskMetrics 1994 CreditMetrics 1997 Integration of credit and market 1998- Enterprise RM2000- (Refer to Olson and Wu, 2007)

13. Olson & Wu, Springer book 2010 Finance: market risk

14. Olson & Wu, Springer book 2010 Finance: Credit risk

15. March 2013. ERM Committee of the American Academy of Actuaries. Insurance Enterprise Risk Management Practices

16. Olson & Wu, Springer book 2010 Risk Keep Top management， CRO Appetite Risk Avoid Risk Transfer Risk Mitigate Keep ATM: ERM Strategy how

17. Outline Why, What, How – 3 step process Tool Our model Conclusion

18. Olson & Wu, Springer book 2010 Risk Appetite Top management，CRO Risk culture, organization, governance HydroOne: a risk management team from top level Risk Identification Market, credit, operations Risk Matrix VaR Risk Enumeration algorithm Risk Review audit TopAimer: ERM Decision Supporthow

19. TopAimer: Uncertain Optimization Model Minimize f ( x, z) Minimize a1x1 + a2x2 + … + anxn Subject To:g 1( x, z) ≤ b1g 2( x, z) ≤ b2… g m( x, z) ≤ bm Subject To:a11x1 + a12x2 + … + a1nxn ≤ b1a21x1 + a22x2 + … + a2nxn ≤ b2… am1x1 + am2x2 + … + amnxn ≤ bm DecisionVariables x UncertainParams z DecisionVariables x All aij depend on uncertain z

20. Hydro One Example – Harvard business review case Jul 03, 2008; also in Wu and Olson, 2009 Case 1: Make All Three Decisions Today Case 2: Make 3rd Decision on ‘Wait and See’ Basis Electricity Pricein Year 1 Demandin Year 1 Buy Ele and Resell Immediately Buy Ele contract and Store for Next Year Storage Cost Electricity Pricein Year 2 Demandin Year 2 Buy Ele and Resell in Year 2

21. TopAimer: based on Excel RiskSolver

22. Conclusions Risky world Risk unavoidable Integration: ERM ERM new philosophy of RM