Scenario Analysis

Sergio Scandizzo

In the Introduction we discussed some of the ways in which risk management can fail. One such failure is a consequence of the assumption that risk can successfully be modelled on the sole basis of historical information or, otherwise said, that we can form a picture of the future by taking a sufficiently sharp look into the past. If historical data is not enough to obtain a reliable estimate of future risks, what is the alternative? Or, rather, what can be done to complement historical analysis and develop a risk assessment that is more effectively forward-looking?

To be sure, this is not an especially new issue in risk measurement nor, generally speaking, in finance. As we will see in Chapter 10, not looking at the future as merely an extrapolation of past events is a fundamental requirement when making decisions in the face of uncertainty. Strategic decisions, in particular, that affect the course of a business in the medium and long term are also, in a way, risk-management decisions and cannot be taken by simply projecting historical data. A book on operational risk management, therefore, cannot overlook this most fundamental of conundrums: how to prepare for future events