Panel, Conference Presentation
Rethinking Risk
Milken InstituteMadelyn Antoncic, Jane Buchan, Laird Landmann, Vlad Portnoy, Myron Scholes, David M. Solomon
- Markets face heightened susceptibility to volatility and shocks compared to the last decade, driven by hard-to-identify bubbles, the lingering effects of negative interest rates, and monetary policies that may encourage excessive risk-taking by central banks.
- A structural shift away from the current negative and low interest rate regime is anticipated, which could render current asset prices unreasonable and trigger a 1994-2005-style unwinding of policy that catches markets by surprise.
- Vulnerabilities persist in the pension and insurance sectors due to underfunding, asset-liability mismatches, and the necessity for pension plans to sell assets without guaranteed liquidity to meet benefit payments amid near-zero cash rates.
- Regulatory efforts to tighten banking risk standards are displacing risk into less liquid areas such as mutual funds and ETFs, potentially creating a lack of liquidity and increasing the probability of a financial firm failure during an upcoming credit cycle downturn.
- Homogeneous adherence to risk models, including Value-at-Risk (VaR) and stop-loss strategies, creates systemic fragility where simultaneous large fund exits or the breakdown of stock-bond correlations during downturns could cause significant market disruption.
- Behavioral anomalies combined with leverage pose risks even within a healthier banking system, while restrictions on derivative legislation could generate unintended consequences for market liquidity.
- Active risk management is projected to yield superior terminal wealth and values compared to index funds or passive strategies, particularly when avoiding tail risks and negative tails where compound returns historically underperform average returns.
- Predictive strategies relying on the VIX or tail risk hedging may prove ineffective over longer periods or against sudden shocks, as selling insurance is a business rather than buying it, and real-time testing of models remains essential for managers.