The Human Reaction to Risk and Opportunity

D. R. Koenig

Chapter 2 in New Frontiers in Enterprise Risk Management, 2008, pp 7-21 from Springer

Abstract: Enterprise risk management is about increasing the value of an enterprise or system. The value of a system today is the discounted present value of some perceived set of possible future states of value of that system. By creating ductile systems that respond well to risk events we can positively change the distribution of and perception about expected future states of value of the system. We can also increase the expected life over which the system is being valued. Quantitative methods, cultural awareness, processes and control are all important to an enterprise risk management framework that is ductile. However, a subtle but important contributor to the impact of a risk event, which defines future states of value, is often ignored in present-day enterprise risk management programs. This may lead to under-appreciation of the value of addressing risks and even false comfort levels in our programs. Intriguing psychological research has been published that shows that the impact of a “risk event” can be either attenuated or exacerbated by the human reaction to that risk event. The human reaction can be affected by present-day risk perceptions and framing, for example, or how risk is processed psychologically. Further, the weighting of possible future states of value, can be impacted by factors such as loss avoidance, small probabilistic changes in state and framing. We are warned, by research in this area, that an over-reliance on quantitative measures can provide a false sense of security, lead to greater amplification of risk events and even generate unexpected risk events when incentives are improperly aligned with risk management objectives. Yet, we naturally seek this security as part of our psychological makeup, perhaps to our own detriment. In total, our awareness of the psychological contributions to how risk events can change the value of our systems is important in any enterprise risk management program and to increasing the value of our enterprise.

Keywords: Risk Management; Risk Perception; Future State; Prospect Theory; Credit Default Swap (search for similar items in EconPapers)
Date: 2008
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DOI: 10.1007/978-3-540-78642-9_2

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