Forging Best Practices in Risk Management

This paper assesses risk management practices and how risk management can be improved. The paper approaches risk management from three perspectives: (1) risk measurement by individual firms, (2) governance and incentives, and (3) systemic concerns. The paper evaluates each approach separately and also discusses the importance of considering them as interrelated. (Working Paper no. 12-02)

Abstract

Existing models of financial instability tend to be based on top-down, partial-equilibrium views of markets and their interactions; they are unable to incorporate the complexity of behavior among heterogeneous firms or the tendency for all types of firms to change their behavior during a crisis. This paper argues that agent-based models (ABMs)—which seek to explain how the behavior of individual firms or “agents” can affect outcomes in complex systems—can make an important contribution to our understanding of potential vulnerabilities and paths through which risks can propagate across the financial system.