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Concept
Financial risk management
Summary
Financial risk management is the practice of protecting economic value in a firm by managing exposure to financial risk - principally operational risk, credit risk and market risk, with more specific variants as listed aside.
As for risk management more generally, financial risk management requires identifying the sources of risk, measuring these, and crafting plans to address them.
See for an overview.
Financial risk management as a "science" can be said to have been born
with modern portfolio theory, particularly as initiated by Professor Harry Markowitz in 1952 with his article, "Portfolio Selection";
see .
The discipline can be qualitative and quantitative;
as a specialization of risk management, however, financial risk management focuses more on when and how to hedge, often using financial instruments to manage costly exposures to risk.
In the banking sector worldwide, the Basel Accords are generally adopted by internationally active banks for tracking, reporting and exposing operational, credit and market risks.
Within non-financial corporates, the scope is broadened to overlap enterprise risk management, and financial risk management then addresses risks to the firm's overall strategic objectives.
In investment management risk is managed through diversification and related optimization; while further specific techniques are then applied to the portfolio or to individual stocks as appropriate.
In all cases, the last "line of defence" against risk is capital, "as it ensures that a firm can continue as a going concern even if substantial and unexpected losses are incurred".
Neoclassical finance theory - i.e., financial economics - prescribes that a firm should take on a project if it increases shareholder value.
Finance theory also shows that firm managers cannot create value for shareholders or investors by taking on projects that shareholders could do for themselves at the same cost;
see Theory of the firm and Fisher separation theorem.
There is therefore a fundamental debate relating to "Risk Management" and shareholder value.
Official source
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