Hello, again. Today must be your lucky day, a double dose of Mike Talkin is what's in store for y'all. Once again, I surfed the net for a blog other than mine, and came across Anna's. Overall I loved all her blogs and will recommend it to everyone I know. The link for the specific blog I chose to critique is http://act-alr.blogspot.com/2009/03/risk-maps.html . The title of this blog is "Risk Maps" and concerns how to go about making a risk map and their use by companies. First, I'd like to explain as best as I can my understanding of the risk map. This will be followed by a short critique of Anna's original blog.
Risk maps help define the certainty of occurrence, using the measures of severity and frequency of risks. Financial, operational and business risks are just a few controlling factors in a business’s success to which mapping would define the most efficient way to prevent these risks. Various forms exist to assess different types of uncertain risks. The risk map is important for assessing “high-stakes” risk. Unexpected risks are the most incorrectly mapped because of their low frequency.
Flood mapping is a very common risk management procedure because it provides the basis of the amount of coverage needed on commercial and residential buildings. FEMA is a government agency which manages risk in daily assessment of property values in a flood zone or flood prone areas. This allows proper coverage on a building and its contents in case of a flood which can cause substantial property damage and unpaid claims. They hire cartographers and engineers to determine special flood hazard area and risk zones. The NFIP, National Flood Insurance Program, uses FEMA’s risk assessment in the flood plan management program consisting of FIRM’s, SFHAs (Special Flood Hazard Areas).
Risk Maps exist to help improve the ecosystem and the environment by assessing factors such as insects, disease and mapping forests to measure the life and death rate of trees. The Geographic Information System database derives evaluated information for the improvement of healing the problems forests tend to have. This process is a “long-term” Forest Health Monitoring program analysis which compiles data into risk maps and models. Forest risk mapping allows more accurate predictions to which forests are prone to drought and fire. Defining these occurrences caused by insects or disease lowers the risk of forest and possibly home consumption by disasters such as massive wild fires and disease outbreaks caused by insects.
As far as Anna's take on the topic, I can't say I disagree with much. I do however disagree with her stance on the correlation between seasonality and car accidents. The weather is tied to certain seasons, which would therefore make the higher rate of accidents in winter correlated to winter itself. The snowy weather is a defining characteristic of winter in a lot of places. I don't think anyone is trying to say that the months of December to February are inherently more likely to have more car fatalities for the simple fact that they are those months. Those months have the bad weather, therefore I don't think it's incorrect to say that the season and car accidents are correlated.
Additional Sources:
http://www.shelterislandrisk.com/resources/documents/RiskMapsMadePractical.pdf
http://www.msc.fema.gov/webapp/wcs/stores/servlet/info?storeId=10001&catalogId=10001&langId=-1&content=productFIRM&title=NFIP%20Flood%20Maps&parent=productInfo&parentTitle=Product%20Information
http://www.srs.fs.usda.gov/sustain/conf/abs/lewis.htm
Tuesday, March 31, 2009
Internal Control
Good day, everyone! Today's topic, a very important one for anybody running a business, is about the benefits of internal control in limiting exposure to unnecessary risk. The role of internal control is to establish a strong and well executed check and balance system throughout a corporation by utilizing audits for an oversight of operations. Internal audits ensure compliance of regulations by defining efficient ways to reduce the risks of asset loss. Risk assessment, monitoring, information and communication, and control operation environment are essential components to the success of an organization.
Insurance Companies use internal audits to verify that procedures are followed and Errors and Omissions risk is minimized. This is done to prevent and correct operations which raise risk and decrease their overall productivity. IIA is a UK based company which prides itself in creating compliance guidelines for the public by publishing a large knowledge base of risk management. IIA is a tool for companies to assure corporate social responsibility and control of internal operations.
Weak control systems can produce undesirable business operations. These systems can be influenced by communication failures between departments and insufficient financial statements which increase the need of risk management. With increased emphasis on the importance of training and using efficient accounting systems along with financial journals, cooperation, and avoiding the consolidation of financial statements, risk can be lowered, therefore creating a strong foundation for a company’s operating system.
Sources:
http://www.ucop.edu/ctlacct/under-ic.pdf
http://www.iia.org.uk/en/Knowledge_Centre/Academic_research/index.cfm
http://www.gm.com/corporate/investor_information/docs/fin_data/gm06ar/content/financials/mar/mar_01.html
Insurance Companies use internal audits to verify that procedures are followed and Errors and Omissions risk is minimized. This is done to prevent and correct operations which raise risk and decrease their overall productivity. IIA is a UK based company which prides itself in creating compliance guidelines for the public by publishing a large knowledge base of risk management. IIA is a tool for companies to assure corporate social responsibility and control of internal operations.
Weak control systems can produce undesirable business operations. These systems can be influenced by communication failures between departments and insufficient financial statements which increase the need of risk management. With increased emphasis on the importance of training and using efficient accounting systems along with financial journals, cooperation, and avoiding the consolidation of financial statements, risk can be lowered, therefore creating a strong foundation for a company’s operating system.
Sources:
http://www.ucop.edu/ctlacct/under-ic.pdf
http://www.iia.org.uk/en/Knowledge_Centre/Academic_research/index.cfm
http://www.gm.com/corporate/investor_information/docs/fin_data/gm06ar/content/financials/mar/mar_01.html
Tuesday, March 24, 2009
Google Risk Map
Above is a risk map based on the risks that Google faces. All information about Google's risks was obtained from Google's Form 10-K at this site http://www.sec.gov/Archives/edgar/data/1288776/000119312507044494/d10k.htm#toc70021_4 . A risk map is a scatter plot with "Frequency" on the x-axis and "Severity" on the y-axis. Risks can be loosely classified into four main categories: High Severity/High Frequency, High Severity/Low Frequency, Low Severity/High Frequency, and Low Severity/Low Frequency. Risks that fall into the High Severity/High Frequency are the events where risk management is necessary to maximize the value of the firm. For Google, these risks are the acquisition of competitors, revenue growth rate decline, and index spammers (manipulation of web search results).
Risks that are in the High Severity/Low Frequency category are the reduction of advertising revenue, international operations/competitors, the interruption of information technology, and new technologies that block ads. A significant amount of Google's revenue comes from advertising and although these events are not that frequent, they still require attention because of their high severity.
In the Low Severity/High Frequency quadrant, we have the risks of losing Google members, intellectual property rights claims, and the violation of US or foreign laws. These events do occur relatively frequently but since their severity is generally low, any risk management would more than likely be wasteful. All other risks on the map are in the Low Severity/Low Frequency category and shouldn't require a lot of attention unless either the severity or the frequency increases.
Obama and the Economy
For today's blog, I decided to read someone else's blog for a change. I know what you're thinking, "but Mike, isn't your blog the only blog worth reading?" Although that might be true, every once in awhile a good post can be found elsewhere. That good post was from Professor Grace himself and was concerning our new president and his affect on the stock market. President Obama’s disinterest with the nation’s weak economy decreases the value of stock prices, hindering the growth of global alliances. These important long-term relationships strengthen the world economy, building confidence among domestic and international consumers. Hugo Chávez's poor opinion of Obama's ignorance for Latin America is a key example of how he is responsible for influencing the decrease in stock prices.(1.) His misdirected concentration of resources used for research (i.e. lifting restrictions on federal funding of human embryonic stem cell research), instead of focusing on steps towards economic growth, abolishes future gain potential in the market.
Another downfall lies in the Social Security and income tax increase which he allocated to the high bracket income earners, in turn making them less apt to put forth maximum effort in the workforce. This will decrease the stock market investment rate, disintegrating prices
further.(2.)
Diminishing long-term investments significantly decreases the value of the stock market by the capital gains tax put forth by the President.(.3) Obama’s taxation on individual investors and large corporations will slow the growth of the market causing the fall of long-term investments making them illiquid if owned over a year. Also, the increase from 15% to 28% on the capital gains tax coupled with the allowance of the 2010 Bush tax cuts to expire, creates an undesirable formula of disaster weakening stock prices.(4.)
Sources:
1. http://kdka.com/politics/hugo.chavez.barack.2.965323.html
2. http://www.consumeraffairs.com/news04/2008/07/mccain_obama.html
3. http://theeprovocateur.blogspot.com/2008/06/barack-obama-vs-stock-market.html
4. http://boards.msn.com/thread.aspx?ThreadID=691804
Another downfall lies in the Social Security and income tax increase which he allocated to the high bracket income earners, in turn making them less apt to put forth maximum effort in the workforce. This will decrease the stock market investment rate, disintegrating prices
further.(2.)
Diminishing long-term investments significantly decreases the value of the stock market by the capital gains tax put forth by the President.(.3) Obama’s taxation on individual investors and large corporations will slow the growth of the market causing the fall of long-term investments making them illiquid if owned over a year. Also, the increase from 15% to 28% on the capital gains tax coupled with the allowance of the 2010 Bush tax cuts to expire, creates an undesirable formula of disaster weakening stock prices.(4.)
Sources:
1. http://kdka.com/politics/hugo.chavez.barack.2.965323.html
2. http://www.consumeraffairs.com/news04/2008/07/mccain_obama.html
3. http://theeprovocateur.blogspot.com/2008/06/barack-obama-vs-stock-market.html
4. http://boards.msn.com/thread.aspx?ThreadID=691804
Tuesday, March 10, 2009
Normal Distribution
Hi, everybody! Today I'm going to talk about the misuse of the normal distribution in the financial world. The normal distribution is a continuous distribution where the mean, the mode, and the median are all equal. Another defining characteristic of the normal distribution is that it has a skewness of 0, in other words it is symmetrical. The standard deviation helps tell us the cumulative probability of getting a certain x within the distribution. The distribution holds that 68.27% of all values fall within plus/minus one standard deviation, 95.45% are within plus/minus two standard deviations, and 99.73% are within plus/minus three standard deviations.
While the normal distribution is appropriate for many phenomena such as people's height, thermal noise, and IQ tests which are actually based on the normal distribution, among others, people tend to overuse it and ignore the long-tails that occur in some financial distributions. Although many financial measures can be approximated using the normal distribution, events such as worst case scenarios regarding cash flow can have some long-tails which don't fit under the normal curve. A distribution such as the pareto or the log-normal would account better for large losses since these distributions are skewed to the right allowing the possibility of large losses to be realized.
While the normal distribution is appropriate for many phenomena such as people's height, thermal noise, and IQ tests which are actually based on the normal distribution, among others, people tend to overuse it and ignore the long-tails that occur in some financial distributions. Although many financial measures can be approximated using the normal distribution, events such as worst case scenarios regarding cash flow can have some long-tails which don't fit under the normal curve. A distribution such as the pareto or the log-normal would account better for large losses since these distributions are skewed to the right allowing the possibility of large losses to be realized.
Monday, March 9, 2009
Stem Cell Policy
It's been awhile since I've been able to bestow some knowledge on y'all and luckily I've come across a very interesting article. The article is from the Wall Street Journal Online and is called "Obama to Reverse Policy on Stem Cells". The link for the article is http://online.wsj.com/article/SB123637565340956847.html . The piece tells us that President Obama will issue an executive order lifting restrictions on federal funding as it relates to stem cell research. Former President Bush had basically grandfathered the stem cell research at the time but stopped any future funding for stem cell lines not being researched. Of course, the hope is that stem cells may help us find cures for diseases such as Parkinson's and diabetes among others. The issue is controversial since opponents view it as taking a life to save a life, since days-old embryos are destroyed in the process.
I know what you're thinking, "Interesting article but I thought this was a blog about risk management?" Well it is, and this is how it relates. Looking at the very big picture, I would suggest that this is a way of the government looking at the risk management of their citizens. If we were to have a cure for diabetes, for example, people would spend less on their continuing diabetes treatment. This would allow people to spend their money elsewhere, in a way helping the economy. The main benefit would be that there would be more people who live longer. This increase in people would lead to more tax revenue for the government. Therefore, the government is managing the risk of their citizens dying.
I know what you're thinking, "Interesting article but I thought this was a blog about risk management?" Well it is, and this is how it relates. Looking at the very big picture, I would suggest that this is a way of the government looking at the risk management of their citizens. If we were to have a cure for diabetes, for example, people would spend less on their continuing diabetes treatment. This would allow people to spend their money elsewhere, in a way helping the economy. The main benefit would be that there would be more people who live longer. This increase in people would lead to more tax revenue for the government. Therefore, the government is managing the risk of their citizens dying.
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