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Risk Management Lessons from the Credit Crisis

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  • Philippe Jorion

Abstract

Risk management, even if flawlessly executed, does not guarantee that big losses will not occur. Big losses can occur because of business decisions and bad luck. Even so, the events of 2007 and 2008 have highlighted serious deficiencies in risk models. For some firms, risk models failed because of known unknowns. These include model risk, liquidity risk, and counterparty risk. In 2008, risk models largely failed due to unknown unknowns, which include regulatory and structural changes in capital markets. Risk management systems need to be improved and place a greater emphasis on stress tests and scenario analysis. In practice, this can only be based on position†based risk measures that are the basis for modern risk measurement architecture. Overall, this crisis has reinforced the importance of risk management.

Suggested Citation

  • Philippe Jorion, 2009. "Risk Management Lessons from the Credit Crisis," European Financial Management, European Financial Management Association, vol. 15(5), pages 923-933, November.
    • Handle: RePEc:bla:eufman:v:15:y:2009:i:5:p:923-933
    DOI: 10.1111/j.1468-036X.2009.00507.x
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    References listed on IDEAS

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    1. Sanjiv R. Das & Darrell Duffie & Nikunj Kapadia & Leandro Saita, 2007. "Common Failings: How Corporate Defaults Are Correlated," Journal of Finance, American Finance Association, vol. 62(1), pages 93-117, February.
    2. René M. Stulz, 2008. "Risk Management Failures: What Are They and When Do They Happen?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 20(4), pages 39-48, September.
    3. Philippe Jorion & Gaiyan Zhang, 2009. "Credit Contagion from Counterparty Risk," Journal of Finance, American Finance Association, vol. 64(5), pages 2053-2087, October.
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