# Risk Management to Optimize the Risk-Return Position

## Content: Risk Management Resolves the Following Problems

The risk management system from Noetzold & Noetzold evaluates business units, investments, projects, products, strategies, etc. under risk-return aspects, based on the results of risk controlling. The aim is a risk-adequate operational and strategic management and the development of an optimalrisk strategy. Questions that will be answered by risk management are:

- What are sensible risk strategies for the company?
- What is the optimal risk strategy given the global corporate strategy?
- What is the optimal corporate risk-return positioning given the risk strategy?
- What is the optimal risk-adequate resource allocation (concerning all corporate units, subsidiaries and / or products)?
- What are the optimal investments (e.g. M&A, project, product) under risk-return aspects?
- Is the existing economic capital adequate for the current risk position or are resources wasted due to imbalance?
- What are the optimal risk limits for the corporate units?
- What is the best protection of earnings and assets against risk driver volatilities?

## Objectives: Optimization of Risk-Return Positions

The objectives of risk management are:

- Development of a risk strategy consistent with the global corporate strategy.
- Efficient implementation of the risk strategy.
- Identification and optimization of the risk-return position based on risk strategy.
- Optimization of capital allocation.
- Risk-adjusted evaluation of investments and products.
- Risk-adjusted pricing.

## Problems: Decision Process Without Consideration of Risk Dimension

An extensive market study *Corporate Risk Management and its Integration into Operational Business* sponsored by Noetzold & Noetzoldidentified some common problems in risk management:

- Resource allocation based on return figures (result: risk premia are not valued; risk takers are rewarded because inherent risk costs are not deducted).
- Missing portfolio optimization technology (result: unrealized corporate-wide diversification opportunities; diversification premia lost to banks, insurance companies, etc.).
- Missing risk management models (result: risk-return inefficient optimizations).
- Incorrect risk aggregation (result: incorrect consolidation of risks; incorrect risk-return figures).
- Risk aggregation with inconsistent probability distributions (result: incorrect risk figures, in particular, underestimation of extreme events, severe errors in predicting Value-at-Risk, Expected Loss, and quantiles).
- Incorrect time-dependence of risks (result: erroneous risk figures when calculating over extended periods, e.g. for projects; incorrect roll-over between periods)
- Use of standard Monte Carlo simulators (result: lack of precision/performance leading to severe errors in predicting Value-at-Risk, Expected Loss, and quantiles;
- Missing risk models (result: incorrect aggregation of risks of different type; severe errors in predicting Value-at-Risk, Expected Loss, and quantiles).
- Use of average values for risk management (result: risk average values are not risk figures, they only adjust planned values by
*expected or average*values, they donot consider the*full spectrum of all possible (not generally expected, not averaged)*outcomes; risk mitigation and steering with risk average values is not risk controlling).

## Solutions: Correct Risk Results Require Advanced Risk Models, Risk Aggregation, and Optimization Models

The quality of risk-return optimizations depends largely on technology, i.e. on financial/mathematical models and on a performant software implementation. Noetzold & Noetzold delivers an innovative risk management solution with the following items:

- Advanced portfolio optimization and simulation technologies.
- Correct risk aggregation (requires high-performance high-precision Monte Carlo simulator).
- Advanced risk management models (different risk types to represent risk events and market fluctuations, including interdependencies, consistent mathematical models).
- Efficient software solution (user friendly intuitive interface, compatible with corporate environment).
- Risk managers and financial engineers with extensive experience.

## Results: Corporate Management under Risk-Return Aspects

The risk management is the basis for an optimal risk-adequate enterprise-wide management. The results of risk management are:

- Optimized risk-return portfolio.
- Optimal risk-return steering.
- Calculation of risk premia and risk-adjusted pricing.
- Sensitivities of risks and risk driver and their impact to earnings and cash flow.
- Future evolution of investments and products.
- Discounting to present values under uncertainty (i.e. risk-adjusted) for investments and projects.
- Risk-adjusted corporate strategy.
- Optimized risk strategy (under consideration of company's risk appetite or risk strategy).
- Risk bundles (correlated risks with large losses and preferred simultaneous occurrence).