Risk Management & Insurance at Universität St. Gallen | Flashcards & Summaries

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Lernmaterialien für Risk Management & Insurance an der Universität St. Gallen

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 Concepts in Risk Management

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  • Uncertainty-Information-Communication-Shareholder Value

  • Their influence on firm value through stakeholders (e.g., creditors, staff, supplier & consumer) and through factor prices and risk premia required by these stakeholder groups 

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Functions & Areas in Risk Management


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  • Assistance in risk identification
  • Implementing programs for loss prevention or loss limitations (e.g., upper limits)
  • Instruction sessions regarding risk management activities
  • Surveillance of compliance with legal guidelines
  • Development of different ways for risk financing e.g., derivatives or contingent capital
  • Claims handling
  • Contract design
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History of Insurance 


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  • Origin based on a “natural risk-bearing community”-> risk sharing by cooperative fusion, by law or via contracts on a commercial basis 
  • For antique and orient, insurance on a commercial basis is not verifiable, but legal or contractual rules for risk sharing in trade – Hammurabi’s Code e.g., caravan insurance 
  • Main pbs in respect to insurance: Adverse selection, ex-post premia & moral hazard
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Ex-post premia 

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  • Adv: no underwriting risk (premia may not be enough for the claims) 
  • Disadv: counterparty risk (people refusing to pay) 
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Risk Identification / Analysis

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Process of systematic detection of risks (of a company), before as well as after its realization (or even near-losses like in aviation)

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Risk Measurement

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Modelling of risks based on models of probability theory / probability distributions

Basis: subjective (assumptions) or objective probabilities (time series analysis)

In general: only modeling of pure random risk (e.g. dice) -> stays stable in time 

  • Risk Measurement may be complex, especially for conditional probabilities 
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St. Petersburg Paradox (1738)


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Daniel Bernoulli was the first to realize that risk measurement is not sufficient. For decision making, individual preferences do play a role!

Coin toss game -> Willingness to pay to enter the game depends on preferences 

  • Risk neutral: based on expected gain of the game (2*1/2 + 4+1/4 +… ) -> the expected gain goes to infinity for endless number of rounds 
  • Risk averse: Empirical do not reflect infinity
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Risk Valuation

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Transformation of risks into values (fair pricing)

  • Risk Valuation: Normative Setting 
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Relative Valuation


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Example – Basis of the Black/Scholes Option Pricing Model  Replicate payoff of options with assets traded on capital markets 

The cashflows of a particular financial instrument (derivative) to be valued are replicated by means of available securities. Present Value Calculus requires Replication!

The price of the duplication portfolio must equal the price of the derivative, otherwise the capital market is not arbitrage-free!

Under these circumstance, individual risk preferences are irrelevant for pricing 

 Example in slides -> The price of a bond depends on rt (rate of return), but the replicating units not (stay stable, linear relationship)

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(Risk-)Preferences and risk valuation are reflected in many empirical phenomena such as:


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  • Existence with positive interest rates
    • Time preference (consuming tmrw has lower value)
  • Insurance with premium > expected loss
    • Willingness to accept the higher premium as a policyholder means risk-aversion
  • Gambling with premium > expected payback to participants
    • Can act as risk-seekers, treat diff situations differently, losses hurt more than potential gains – framing problem 
  • Bond interest rate 
    • Higher risk premiums are demanded for riskier bonds -> preference if higher pb to be paid payback -> interest rate spread increase
  • Foreign Exchange Markets
    • preferences for currencies
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Example of Risk Valuation


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  • Insurance Market -> “average” claim < premiums
  • Interest Rate Spread
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First step for risk management

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planning, forecasting & management of risks relevant for private individuals or a company (respectively). 

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Q:

 Concepts in Risk Management

A:

  • Uncertainty-Information-Communication-Shareholder Value

  • Their influence on firm value through stakeholders (e.g., creditors, staff, supplier & consumer) and through factor prices and risk premia required by these stakeholder groups 

Q:

Functions & Areas in Risk Management


A:
  • Assistance in risk identification
  • Implementing programs for loss prevention or loss limitations (e.g., upper limits)
  • Instruction sessions regarding risk management activities
  • Surveillance of compliance with legal guidelines
  • Development of different ways for risk financing e.g., derivatives or contingent capital
  • Claims handling
  • Contract design
Q:

History of Insurance 


A:
  • Origin based on a “natural risk-bearing community”-> risk sharing by cooperative fusion, by law or via contracts on a commercial basis 
  • For antique and orient, insurance on a commercial basis is not verifiable, but legal or contractual rules for risk sharing in trade – Hammurabi’s Code e.g., caravan insurance 
  • Main pbs in respect to insurance: Adverse selection, ex-post premia & moral hazard
Q:

Ex-post premia 

A:
  • Adv: no underwriting risk (premia may not be enough for the claims) 
  • Disadv: counterparty risk (people refusing to pay) 
Q:

Risk Identification / Analysis

A:

Process of systematic detection of risks (of a company), before as well as after its realization (or even near-losses like in aviation)

Mehr Karteikarten anzeigen
Q:

Risk Measurement

A:

Modelling of risks based on models of probability theory / probability distributions

Basis: subjective (assumptions) or objective probabilities (time series analysis)

In general: only modeling of pure random risk (e.g. dice) -> stays stable in time 

  • Risk Measurement may be complex, especially for conditional probabilities 
Q:

St. Petersburg Paradox (1738)


A:

Daniel Bernoulli was the first to realize that risk measurement is not sufficient. For decision making, individual preferences do play a role!

Coin toss game -> Willingness to pay to enter the game depends on preferences 

  • Risk neutral: based on expected gain of the game (2*1/2 + 4+1/4 +… ) -> the expected gain goes to infinity for endless number of rounds 
  • Risk averse: Empirical do not reflect infinity
Q:

Risk Valuation

A:

Transformation of risks into values (fair pricing)

  • Risk Valuation: Normative Setting 
Q:

Relative Valuation


A:

Example – Basis of the Black/Scholes Option Pricing Model  Replicate payoff of options with assets traded on capital markets 

The cashflows of a particular financial instrument (derivative) to be valued are replicated by means of available securities. Present Value Calculus requires Replication!

The price of the duplication portfolio must equal the price of the derivative, otherwise the capital market is not arbitrage-free!

Under these circumstance, individual risk preferences are irrelevant for pricing 

 Example in slides -> The price of a bond depends on rt (rate of return), but the replicating units not (stay stable, linear relationship)

Q:

(Risk-)Preferences and risk valuation are reflected in many empirical phenomena such as:


A:
  • Existence with positive interest rates
    • Time preference (consuming tmrw has lower value)
  • Insurance with premium > expected loss
    • Willingness to accept the higher premium as a policyholder means risk-aversion
  • Gambling with premium > expected payback to participants
    • Can act as risk-seekers, treat diff situations differently, losses hurt more than potential gains – framing problem 
  • Bond interest rate 
    • Higher risk premiums are demanded for riskier bonds -> preference if higher pb to be paid payback -> interest rate spread increase
  • Foreign Exchange Markets
    • preferences for currencies
Q:

Example of Risk Valuation


A:
  • Insurance Market -> “average” claim < premiums
  • Interest Rate Spread
Q:

First step for risk management

A:

planning, forecasting & management of risks relevant for private individuals or a company (respectively). 

Risk Management & Insurance

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