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Economists’ hubris – the case of risk management

In this, the third paper in the Economists’ Hubris series, we highlight the shortcomings of academic thought in developing models that can be used by financial institutions to institute effective enterprise-wide risk management systems and policies. We find that pretty much all of the models fail when put under intense scientific examinations and that we still have a long way to go before we can develop models that can indeed be effective. However, we find that irrespective of the models used, the simple fact that the current IT and operational infrastructures of banking institutions does not allow the management to obtain a holistic view of risk and the silos they sit within means that instituting an effective enterprise-wide risk management system is as of today nothing more than a panacea. The main worry is that it is not only academics who fail to realize this fact, practitioners also believe that these models work even without having a holistic view of the risks within their organizations. In fact, we can state that this is the first paper in which we highlight not only the hubris exhibited by economists but also the hubris of practitioners who still believe that they are able to accurately measure and manage the risk of the institutions they manage, monitor, or regulate.

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Article provided by Capco Institute in its journal Journal of Financial Transformation.

Volume (Year): 28 (2010)
Issue (Month): ()
Pages: 27-35

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Handle: RePEc:ris:jofitr:1408
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  1. Boudoukh, Jacob, et al, 1997. "Pricing Mortgage-Backed Securities in a Multifactor Interest Rate Environment: A Multivariate Density Estimation Approach," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 405-46.
  2. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  3. Frank Fabozzi & Vinod Kothari, 2007. "Securitization: The Tool of Financial Transformation," Yale School of Management Working Papers amz2495, Yale School of Management, revised 01 Jul 2007.
  4. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  5. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
  6. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  7. Dizdarevic, Predrag & Shojai, Shahin, 2004. "Integrated data architecture — the end game," Journal of Financial Transformation, Capco Institute, vol. 11, pages 62-65.
  8. Hand, David & Yu, Keming, 2009. "Justifying adverse actions with new scorecard technologies," Journal of Financial Transformation, Capco Institute, vol. 26, pages 13-17.
  9. Hunter, Greg, 2009. "Anatomy of the 2008 financial crisis: an economic analysis postmortem," Journal of Financial Transformation, Capco Institute, vol. 27, pages 45-48.
  10. Keith Kuester & Stefan Mittnik & Marc S. Paolella, 2006. "Value-at-Risk Prediction: A Comparison of Alternative Strategies," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 4(1), pages 53-89.
  11. Shojai, Shahin, 2009. "Economists' Hubris - The Case of Mergers and Acquisitions," Journal of Financial Transformation, Capco Institute, vol. 26, pages 4-12.
  12. Shojai, Shahin & Feiger, George, 2009. "Economists’ hubris – the case of asset pricing," Journal of Financial Transformation, Capco Institute, vol. 27, pages 9-13.
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