Investor Analytics has released its joint study Tomorrows Risk Management: How behavioral economics, cognitive studies and complexity science add up to more than their own sum, with BNY Mellon on the future of risk management.
The report recommends that those managing risk – whether asset owners or asset managers – incorporate lessons of known human biases into market stress tests and scenarios. It also shows that traditional economics does not adequately describe real markets and the potential impacts on financial portfolios.
The study has some interesting findings, including showing that humans are risk averse when it comes to gains, but risk takers when it comes to losses, explaining that more credibility is given to stories or scenarios that are rich in detail, even though these tend to be statistically less probable to happen. As well as demonstrating that rather than diminishing with improved efficiency, volatility is actually a necessary component for markets to exist in the first place and does not change with efficiency.
The report conveys the need for managers, investors and risk professionals to take a fresh look at how they determine risk in their portfolios by incorporating not just the fact that we are irrational decision makers, but the ways in which we are irrational in making our decisions.
Investor Analytics and BNY Mellon hope that the study will cause risk management to look very different in the future and encourage the need to provide enhanced analysis for practitioners to analyze risks within their portfolios.