Event Risk and Its Management
Event risk involves a severe and sudden shock that can arise from any general type of risk, including human error, operational risk, natural disasters, currency devaluations, and stock market crashes.
Difficult to predict
Event risks are difficult to predict, but once an event strikes, we know there will be aftershocks. Hence, it is important to readjust quickly to new conditions--this means re-evaluating risks, looking for new risk concentrations, and taking corrective action if necessary.
Events can trigger liquidity crises that may make it difficult to readjust or find funding for positions.
Often the initial shock is not the worst: One event can precipitate other events and lead to contagion across markets, which becomes systemic risk that affects everyone.
One way to prepare for event risks is to conduct regular stress testing. The greatest challenge in stress testing is generating credible worst-case scenarios that show how particular events could affect all relevant markets. For example, we might have a stress test of the U.S. markets: A computer virus cripples Microsoft operating systems and the U.S. equity market starts to sell off. How far will it go? How will other global markets react?
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