Risk Management Part I
Financial markets constitute a complex, dynamic self-learning system. As a rigorous quantitative discipline that attempts to model this system and forecast its behavior, risk management has attracted a lot of brilliant people with academic backgrounds in physics, mathematics, and other natural sciences.
While usually providing great insights into the analytical aspects of financial phenomena, these "rocket scientists" may oversimplify financial modeling problems by mapping the unchanging nature of most physical systems onto the evolving and adapting behavior of the nearly efficient financial markets.
Since the underlying "truths" of financial markets (as determined theoretically or empirically) regularly change as more market participants learn about them, very few problems in other fields of human knowledge can compete in complexity with financial modeling.
While the laws of physics do not change when an important relationship is discovered, fundamental characteristics of financial markets do change as knowledge about them is assimilated into the practice of market participants.
The stochastic behavior of systematic risk factors and even their cause-and-effect relationships "mutate" because of investors' knowledge about them. Hence all risk management practices require frequent "reality checks" to verify that the forecasts of risk models are still consistent with actual market behavior. More to come in Part II.
Blackrock: Risk Management Approaches
While usually providing great insights into the analytical aspects of financial phenomena, these "rocket scientists" may oversimplify financial modeling problems by mapping the unchanging nature of most physical systems onto the evolving and adapting behavior of the nearly efficient financial markets.
Since the underlying "truths" of financial markets (as determined theoretically or empirically) regularly change as more market participants learn about them, very few problems in other fields of human knowledge can compete in complexity with financial modeling.
While the laws of physics do not change when an important relationship is discovered, fundamental characteristics of financial markets do change as knowledge about them is assimilated into the practice of market participants.
The stochastic behavior of systematic risk factors and even their cause-and-effect relationships "mutate" because of investors' knowledge about them. Hence all risk management practices require frequent "reality checks" to verify that the forecasts of risk models are still consistent with actual market behavior. More to come in Part II.
Blackrock: Risk Management Approaches
Comments