Risk Management and Value Creation in ... - Arabictrader.com

Rationales for Risk Management in Banks 69
Let us now turn to a world where firms try to manage risks on behalf
of not well-diversified investors (B. in Table 3.1). These investors care about
specific risks in their portfolios. However, in neoclassical markets, there would
be no reason to hold such portfolios because they are inferior to welldiversified
portfolios that can be created without any costs. 76 Nonetheless,
if those investors and portfolios exist, it is out of the question that risk
management conducted on the level of individuals can create value. 77 However,
the question here is whether corporate risk management can also create
value. Again, we distinguish between financial (as represented in the third
row labeled I. in Table 3.1) risk management and changes in operations (as
represented in the fourth row labeled II. in Table 3.1).
Financial risk management scenarios:
Value-creating scenario (❼ in Table 3.1): Corporate risk management
working on specific risks [dimension (1)] can create value because investors
decided not to use the opportunity to diversify their portfolios.
Such investors will appreciate diversification provided by the firm. Even
though these actions will not increase the overall firm value (which is
only dependent on systematic risks), it will increase the consumption
stream available to individual investors. However, if costs are associated
with such actions at the corporate level, the resulting decrease in
firm value has to be outweighed by the overall value increase to individuals
in order to be beneficial overall.
Unclear effect scenario (❽ in Table 3.1): Since systematic risk [dimension
(2)] can always be bought or sold in the market at fair terms, there
will be no benefit for individual investors because they can replicate
those transactions free of charge on their own. However, the same cases
as in scenario ❸ and ❹ need to be considered to decide on whether the
net effect on value creation is neutral, positive, or negative.
In the case of not-well-diversified portfolios, asset allocation and diversification
can be insufficient risk-management tools, and individual investors
can be made better off by using derivatives. However, as mentioned,
firms cannot improve value for their investors by using derivatives. 78
76 According to capital markets theory, investors would only split their assets between
the risk-free asset and the market portfolio, which—by definition—is perfectly
diversified.
77 See Stulz (2000), pp. 2--7–2-50.
78 See Stulz (2000), pp. 2-50–2-51.