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Abstract
In this paper, the future trends and challenges of financial risk management are considered. First, the historical developments and current status of financial risk management are assessed. Then, key features of the financial industry in the digital economy are discussed. It is argued that the technology innovations, particularly in computing and telecommunication, will continue to have an important influence on the future development of financial risk management. Based the past and present of financial risk management as well as the general trends in the financial industry, some future trends and challenges of financial risk management in the digital economy are discussed. Finally, some implications for financial institutions, corporations and emerging economies are given.
Introduction
Risk is an old concept associated with uncertainty. There have been many different definitions. However, there has been little consensus on the concept of risk, see Gao (2001) for a more detailed discussion. In the course of running a business, decisions are made in the presence of risk. A decision-maker can confront one of two types of risk. Some risks are related to the underlying nature of the business and deal with such matters as the uncertainty of future sales or the cost of inputs. These risks are called business risks. Another class of risks deals with the uncertainty of such factors as interest rates, exchange rates, stock prices, and commodity prices. These are called financial risks.
Most businesses are accustomed to accepting business risks such as the uncertainty of future sales. Indeed the acceptance of business risks and the potential rewards can come with it are the foundations of the free market economy. But financial risks are a different matter, as often businesses are not accustomed to accepting and managing them. The paralysing uncertainty of volatile interest rates can cripple the ability of a firm to acquire financing at reasonable cost. Firms that operate in foreign markets can have excellent sales performance offset if its own currency is strong. Managers of portfolios deal on a day to day basis with widely unpredictable and sometimes seemingly irrational financial markets. These examples clearly demonstrate that financial risks can be important for many businesses.
In coping with growing financial risks, various derivative products (e.g., options, swaps) have been developed in...