A framework for strategic financial risk management

Abstract

Strategic risks represent the largest challenge for corporate risk management, often due to lack of data or incompatibility with existing financial modeling frameworks. Indeed, industry surveys found that from 2002 to 2012 strategic risks accounted for over 80% of the cases of significant shareholder value loss among Top 1000 companies. To meet the challenge, we propose a practical framework that includes (i) a collaborative environment to build (in an intuitive yet structured fashion) a graph representing the relationships between mitigation actions, risks, and affected drivers of a company's financial model, (ii) a set of rules to transform this graph into a probabilistic model, allowing for the automatic generation of questionnaires to elicit risk information from domain experts, (iii) an aggregation technique to combine opinions of multiple experts, (iv) simulation to quantify the effects of the risks and mitigation actions on key financial outcomes, and to compute, for example, the probability of achieving a given profit target conditional on a portfolio of mitigation actions, (v) an evaluation of mitigation actions in terms of their risk reduction, and (vi) a cost-benefit analysis to help decision makers determine a mitigation investment strategy.