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Risky Business: Are There New Ways of Looking at Risk?
Risk and volatility were the words most often heard and discussed by investors in 2011, and looking at the first month of 2012, it appears that this year will be as volatile and filled with risk as was 2011. Since the collapse of Lehman Bros. in 2008, market practitioners and academicians have been trying to understand what went wrong and how to protect us in the next financial crisis. Very important lessons have been learned, and many established theories and assumptions have been revisited and challenged.
One of them is the understanding of risk itself. According to Modern Portfolio Theory, risk is defined in terms of a variance around an expected rate of return. This understanding of risk, easily accepted by an econometrician or a statistician, proved to be inadequate for pension fund managers whose actual risk is not being able to meet their fund’s fiduciary responsibilities to its members. So it is more important for them to implement their risk management stra