Risk Management: Foundations for a Changing Financial World

CHAPTER 10

RISK MEASUREMENT VERSUS RISK MANAGEMENT^j

D. Sykes Wilford

Risk management garners much attention in the investment management industry, but it differs from risk measurement. Portfolio managers, consultants, and clients each require different portfolio-related information. Managing the information derived from risk measurement is central to the portfolio management process. Portfolio managers must balance expected returns against the risk accepted to earn those returns. For them, risk measurement information has always been an integral part of the portfolio management process. But as the industry evolves, others are becoming interested in the structure of the portfolio risks taken. Firms not providing sufficient information will miss opportunities to acquire and retain clients.

Risk measurement and risk management are both integral to the portfolio management process, but the two are very different. Risk measurement gauges changes in portfolio value corresponding to different market conditions. It is a risk management tool. Risk management focuses on identifying and controlling portfolio risks. Management entails action to make the measurement activity useful. Measuring systems used for portfolio creation are also not the same as those used to manage portfolio risk. Confusing the two can lead to the underestimation of risk, as can be argued in the Long-Term Capital Management (LTCM) crisis case. Risk measurement information is based on ex post analytics applied to existing ...