In any company where taking proprietary risk is a core activity, the risk management function plays a crucial role. Put simply, in trading environments, traders actively seek risks for higher rewards and risk managers analyze and monitor these risks. They are also expected to caution against excessive risks that traders might engage in. The most prevalent approach in describing collaboration between traders and risk managers is to emphasize that the latter are consistent and unbiased in their analysis of the risk deployed.
In the article How risk managers can improve their performance by being mindful of their biases, Robert Horster argues that the above mentioned model of consistency and absence of bias may not reflect reality. Risk managers are human beings. Where judgment rather than cool statistics is used to analyze risk, risk managers may not be consistent and unbiased in their approach to risk. Biases, in turn, are likely to be influenced by the traders’ profit and loss accounts – for instance, losses may prompt risk managers to become overcautious. Moreover, if risk managers are mindful of their biases, they may in fact improve their judgment by selectively acting counter to their bias. Robert Horster calls this situational risk management. Good risk management entails applying situational approaches.
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