by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
Coming from a background in investments (and nuclear physics), we always talk about back-testing a new idea. In other words, how would have the world unfolded (differently, better, worse) if we implemented (did not implement) a given strategy. Back-testing however seems to be a rarity in the world of risk management (with the possible exception of financial risk management). Perhaps this is a major oversight of the profession.
I realize that back-testing operational or strategic risk is tricky. A lot of assumptions need to be made, and models of outcomes need to be constructed. Perhaps however it is the exercise of working through the necessary assumptions and constructing the models that would make it such a useful and valuable exercise.
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