[...]... contracts Like market risk, credit risk comes in a variety of forms, including default risk, 14 THE NATURE OF CATASTROPHE presettlement risk, settlement risk, and contingent risk There is also, as noted above, a market driven form of credit risk, spread risk, which represents a key intersection between the credit and market risk dimensions ٗ Default risk: Default risk represents the risk of loss should... feature of our landscape Knowing this, we may discover that the standard risk management framework that is applied to “normal,” or “average,” or “close-to-the-mean” risks is insufficient for dealing with a financial “meltdown.” Determining how the framework might be enhanced emerges as an important theme of our work Risk classifications Pure and speculative Financial and nonfinancial Financial catastrophes... angles: pure and speculative risks, financial and nonfinancial risks, and noncatastrophic and catastrophic risks These are not mutually exclusive categorizations and indeed often intersect For instance, it is possible for an institution to be exposed to a speculative, financial risk that is noncatastrophic in nature (e.g., a call option on dollar/yen exchange rates), or a pure, nonfinancial risk that... an overarching risk management framework, discuss different classes of risk, consider in brief the essential probability and value characteristics of risk, and then relate some of these issues to catastrophe, which we will build on in subsequent chapters 3 4 THE NATURE OF CATASTROPHE THE RISK MA NAGEMENT FR A MEWORK To deal effectively with risk, we must understand our risk exposures and place them... of financial risks is relevant primarily for financial crises, but can also be considered in the context of certain other devastating events that have a secondary impact on financial markets and economic activity (e.g., terrorist attacks) Figure 1.2 summarizes the key risk classifications described above Risk classifications Pure and speculative Financial and nonfinancial Figure 1.2 Summary of risk. .. leads us to the source of a risky exposure, which is essential if we are to understand how risk impacts activities and how it can ultimately be managed Financial risk Financial risks come in different forms, each with the potential of impacting financial and corporate institutions (as well as individuals); since our key topic of discussion is the catastrophic impact of financial risks we will go into detail... protective, while in the case of speculative risks, they maybe considered defensive or offensive Most of our discussion in the book will relate to the downside scenarios, that is, pure risks and the loss dimensions of speculative risks Financial and nonfinancial risks The second dimension of categorization considers whether a risk exposure is financial or nonfinancial in nature This is an important consideration... are characterized by a notional amount, but where the actual risk exposure is a fraction of the notional and reflects the mark-to-market value and some potential future exposure Should a default occur, the amount owed to creditors will relate to the mark-to-market value and replacement cost ٗ Settlement risk: Settlement risk relates to the risk of loss due to the brief period of time during which a... time, adding to exposure and the prospect of losses in the event of default.3 Nonfinancial risk Nonfinancial risks relate to a broad range of operating risks that a company is likely to face in the normal course of its business – and, as the name suggests, exclude all financial exposures The exact nonfinancial risks a firm will encounter depend on the industry in which it operates and the specific construct... systematic and an idiosyncratic element to such nonfinancial exposures While the list of potential exposures in this area is quite long, we can define the key areas of exposure to include legal risk, operational risk, and property and casualty risk Legal risk: Legal risk represents the risk of loss should some aspect of the legal process within a company fail to operate as intended This can TAXONOMY OF RISK . three dif- ferent angles: pure and speculative risks, financial and nonfinancial risks, and noncatastrophic and catastrophic risks. These are not mutually exclu- sive categorizations and indeed. pure risks and the loss dimensions of speculative risks. Financial and nonfinancial risks The second dimension of categorization considers whether a risk exposure is financial or nonfinancial. GOVERNANCE WEATHER RISK MANAGEMENT ASIA PACIFIC DERIVATIVE MARKETS EMERGING ASIAN FIXED INCOME MARKETS THE CREDIT RISK OF FINANCIAL INSTRUMENTS Risk and Financial Catastrophe ERIK BANKS © Erik Banks