An Exploration of the Evolution of Risk: Past, Present and Future

Nicholas C Silitch

The shape and texture of debt instruments and portfolios have morphed materially since the early 1900s, and while this has changed the way credit risk manifests, it has not changed the foundational need for the analysis of each issuer’s business model, cashflows and balance sheet. What has changed is the ability to assemble broadly diversified portfolios of credit risk efficiently and economically; this is critically important when investing in instruments where the distribution of outcomes is severely limited on the upside and conceivably unlimited on the downside. This evolution has made it vitally important to understand the drivers of correlation, and how they may change through time, in assessing portfolios of credit risk. While for many the evaluation of correlations is limited to a mathematical exercise formed by the careful analysis of historical return data, this approach is inherently shortsighted. The data is inevitably limited to a much shorter time period than we would like: 10, 15 or 30 years. Consequently, the number of truly systemic events that occur within the lifespan of our data is limited. How do we enhance our understanding of what awaits us as we look to the