An Introduction to Behavioural Risk Management

René Doff

Let us start with a crucial question: what is behavioural risk management? Behavioural risk management aims to deal with the behavioural biases of human beings in their assessment of problems, risks, solutions and decisions. It appears that human beings do not act so rational and logical as was once thought, especially when uncertainties are involved and decisions are to be made. Behavioural risk management aims to address this problem and to induce decision-makers to take the right decisions while managing risks.

Risk management as a separate profession can be traced back to the early 1980s, although risk management as an activity has a much longer history. It is fair to say that more explicit frameworks to manage risks, and to label them as such, were developed in the financial industry and then exported into different industries. Therefore, risk management in finance is where traditional economic theories have been applied in great detail, such as portfolio optimisation and option pricing. Hence, these theories and their application are now widely accepted within banking, insurance, pension funds and asset management. One of the key risk management tools is VaR, an