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Fisher College of Business Working Paper Series

Charles A. Dice Center for Research in Financial Economics
Risk Management Failures: What Are They and When Do They Happen?
René M. Stulz, Department of Finance, The Ohio State University, NBER, and ECGI

Dice Center WP 2008-18
Fisher College of Business WP 2008-03-017

October 2008

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Risk management failures: What are they and when do they happen?
René Stulz*

October 2008

Abstract A large loss is not evidence of a risk management failure because a large loss can happen even if risk management is flawless. I provide a typology of risk management failures and show how various types of risk management failures occur. Because of the limitations of past data in assessing the probability and the implications of a financial crisis, I conclude that financial institutions should use scenarios for credible financial crisis threats even if they perceive the probability of such events to be extremely small.

* Reese Chair of Banking and Monetary Economics, Fisher College of Business, Ohio State University, NBER, and ECGI. I am grateful for assistance from Jérôme Taillard and Mike Anderson, and for comments from Rich Apostolik, Don Chew, Cliff Smith, and Peter Tufano.

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In commentaries on the financial crisis that started during the summer of 2007, a constant refrain is that somehow risk management failed and that there were risk management failures at