Review of Key Risk and Uncertainty Theories Influencing Contemporary Financial Economics

Colin Read
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Colin Read: Department of Economics and Finance, State University of New York, Plattsburgh, NY, USA

International Journal of Risk and Contingency Management (IJRCM), 2012, vol. 1, issue 4, 18-27

Abstract: Ironically, the 2008 credit crisis and the subsequent global financial meltdown were brought about by efforts of those whose stated purpose was to manage risk. Somehow, the efforts of financial regulators to manage and contain uncertainty created the greatest downside risk experienced since the Great Depression. At this juncture in financial history, it is purposeful to examine the meaning of risk and uncertainty, how it is priced, the assumptions one makes when one uses market-priced risk hedges, and the degree to which the modern science of financial risk management informs or obfuscates the very nature of risk. This paper performs such a retrospective analysis of key risk theories and how they impact financial markets, through the developments of innovators: Daniel Bernoulli, Carl Friedrich Gauss, Louis Bachelier, Jacob Marschak, Harry Markowitz, William Sharpe, Paul Samuelson, Fischer Black, and Myron Scholes. This paper makes an additional contribution to the literature by identifying unresolved issues that require additional research to improve risk management in financial markets. In particular, this paper concludes that while the author have numerous tools to manage risk, they have few tools to manage uncertainty, the latter of which is where future research should be undertaken.

Date: 2012
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