Risk Management For Global Financial Organizations: Applying Large-Scale Optimization

Princeton University, Princeton NJ

Investigators

Abstract

The research focuses on risk management at the strategic (enterprise) level, with an emphasis on global financial companies. The research will demonstrate that a decentralized optimization-based planning model provides a practical approach for global risk management. Successful risk management depends upon an organization's ability to achieve well-defined objectives. These systems not only protect an organization against losses, but also increase risk-adjusted profits. The research will compare leading approaches for optimizing a firm under uncertainty, including resource and price directive procedures. Senior management and regulators will evaluate the strategies. Building on previous work with financial companies, the research will extend ongoing risk management systems to address decentralized elements. The research will study the selection of firm-critical scenarios as part of risk transfer mechanisms. Since dynamic financial models possess benefits over traditional single-period approaches, decentralized optimization will be deployed in a discrete-time, multi-period setting. The research addresses problems in current risk management practices: (1) historical data may misrepresent the future, especially regarding rare events; (2) financial organizations fail to predict future performance under a set of plausible scenarios; (3) regulations may work at cross purposes for mitigating enterprise risks; (4) regulators lack experience in technical aspects; and (5) managers possess inconsistent guidelines for evaluating risks. Each topic will be evaluated during the project tenure. Global risk management has become a significant concern due to several emerging trends. Modern financial companies span a wide spectrum of activities in global markets from insurance to investment banks, retail banks and security brokerages. While these organizations attempt to diversify risks, recent events have shown that large financial organizations are unable to fully anticipate their overall loss exposure, especially during stressful conditions. European financial firms have lost considerable market value due to convergence of losses. In the US, pension plans have reduced their ability to pay beneficiaries. The research's risk management techniques can have a positive impact on professional practice. Companies that operate in an efficient manner are less likely to fail, thus reducing external societal costs. The current US pension problem is an example, whereby improved asset-liability management would have been beneficial.