Any control and management of risks presupposes that risks have been identified. To this end, the question must be asked what is meant by “risk”. There are several definitions:
1. Risk = damage to a part. In insurance, risk is understood as the possibility, with a certain probability, that a (clearly definable and more isolated) damage will occur. The damage is caused by breakage, misconduct, or external influences. The actuarial risk is therefore described by the type of possible damage, financially valued by the amount of the damage, and the probability of occurrence.
2. Risk = undesirable overall result. The lexicon defines risk as the possibility of an undesirable or harmful outcome of economic activity. With the “outcome of economic activity” an overall result is addressed rather than isolated damage at a single point, as is the case with the actuarial concept of risk. What is "undesirable" depends on preferences. In a company, preferences are expressed through costs that arise in the event of poor results.
Was „abträglich“ ist, hängt von der individuellen Situation der Unternehmung ab. Hier können Verpflichtungen eine Rolle spielen, genereller die Capital structure und allgemein die Fähigkeit, Risiken tragen zu können. Für eine hoch verschuldete Unternehmung sind deshalb andere Ergebnisse abträglich als bei einer Kapitalstruktur mit mehr Eigenmitteln.
Important: an "undesirable or harmful outcome" does not have to be a disaster or a threat to existence. Developments that force you to change your business plan, initiate complex special measures, have to communicate bad news at an inopportune time, or if interesting opportunities cannot be seized are also detrimental.
3. Risk = risk of disaster. The existence and continuation of the company almost always represents an important value, for example because intangible goods, the brand name, employees with specific knowledge can only be used to add value if the company is continued. The perspective of the KonTraG seems to be to concentrate on the possibility of "existence-threatening developments".
4. Risk = dispersion of the return. In the classic portfolio theory as developed by MARKOWITZ, SHARPE, TOBIN and others, risk is not viewed solely as a possibility or probability for an adverse development. The concept of risk in financial theory is more associated with uncertainty.
Uncertain developments can also end well or better than expected. In other words, in finance theory as in the practical world of finance, the concept of risk encompasses both dangers and opportunities.
Investment results, financial results or returns are modeled as uncertain, and probability distributions can be given on the basis of information or historical comparisons. The risk is the spread of the return. We speak of volatility when we mean the spread of the returns noted in continuous notation. The dispersion or standard deviation is a measure of how much the returns and thus the financial results will deviate from their expected value. The square of the dispersion, the variance, is known to be the mean square deviation. Risk is therefore a measure of either inherent coincidence or the imprecise predictability of developments due to less information.
This term does not initially express how detrimental a financial result that is poor in relation to the expected value (downside risk) and how beneficial a financial result that is better in relation to the expected value (upside potential) would be. When defining risk as the spread of the return, there is initially no indication of which disadvantage or which benefit reduction or which decrease in value is associated with a certain spread.
5. Risk = Beta. The same applies when the financial risk is measured by beta. Beta is a measure of the spread of returns that could not be further reduced through diversification. Beta expresses the systematic risk that is no longer diversifiable. Beta is a variable that plays its special role in a model, the capital asset pricing model, CAPM.
6. Risk = shortfall risk. In portfolio theory, a variant of the concept of financial risk (dispersion of the return, beta) was developed, in which only the downside risk is considered and the upside potential is excluded.
The investor or financial beneficiary first expresses a financial goal, a target, a minimum result or a minimum return. This goal often results from the financial situation, from profit targets, from the capital structure, from obligations: The investor wants to be able to service the liabilities from the investment result of the assets.
The event of missing the minimum return is known as a shortfall. The probability of missing this minimum return is called shortfall risk.
Ziel des Portfoliomanagers ist dann die Asset-Allocation oder die Risikopolitik so zu wählen, daß das Shortfall-Risiko nicht größer ist als eine gewisse, vorher festgesetzte, kleine Zahl wie etwa 1% oder 5%.
The shortfall approach is therefore seen as particularly relevant for companies in the financial sector.
7. Risk = VaR. This view is expressed in Value-at-Risk (VaR), a modern risk measure favored by regulatory authorities for financial institutions.
The VaR asks the question of the worst investment result or the greatest loss. A deadline is also assumed for specifying the greatest loss. This is often the period of time within which emergency measures can be implemented. For banks, for example, 10 days is the norm.
However, the VaR is not aimed at the worst-case scenario and the maximum conceivable loss. In many cases, the worst case means losing everything. The likelihood of this is often very low in practical situations. A look at the worst case would only mean extreme safety precautions, the complete avoidance of an exposure. A look at the worst case does not lead to a policy that is cautious but is not extremely geared towards absolute security.
Based on these considerations, a probability is given for VaR, often 1 percent, and the question is asked what is the maximum financial loss that can occur within the underlying period if the 1% of the worst developments are excluded