Economic risk

Economic risk
See also

Risk has multiple definitions. Preston B. Cline claims that nowadays most definitions of risk define it by its result: “Potential for loss…”[1]. Ramady M. A. suggest that “risk is a situational characteristic of activity that may have an uncertain outcome and negative effects in case of failure.”[2].

The economic risk “should be considered as a process of decision-making under conditions of uncertainty and with respect to economic, political, moral, psychological and other largely negative consequences”[3]. International Country Risk Guide gives tools to weighting and classifying economic risk[4].

Functions of risk

Risk has two functions [5]: stimulative and protective.

  • The stimulative function – has two aspects: constructive and destructive. The first aspect highlights the role of risk as a catalyst in solving economic obstacles, particularly in settling innovative investment decisions. The second aspect explains ‘’that making and implementing decisions with undue risk results in adventurism’’.
  • The protective function - also has two aspects: historic/genetic and social/legal. The first aspect states that everyone "spontaneously search for forms and means of protection from probable negative consequences". This aspect is illustrated in practice through the formation of emergency reserve funds and insurance from entrepreneurial risks. The second aspect highlights a need for establishing the categories of risk justification into economic, labor and criminal legislation.

Economic risk factors

Various factors have an impact on economic risk. Ling D. C. and Naranjo A. considered 7 factors, such as[6]:

  • MKT - "The market portfolio is the excess return on a value-weighted portfolio of NYSE, AMEX, and NASDAQ stocks
  • PREM - The bond default premium is the difference between the quarterly yield on a portfolio of bonds rated Baa by Moody's Investor Services and a portfolio of long-term U.S. government bonds
  • TERM - The term structure premium is defined as the change in the difference between the quarterly yield of a 10-year Treasury bond and a 3-month Treasury bill
  • RLTBL - The real three-month Treasury bill return is the return on a three-month Treasury bill less the quarterly inflation rate as measured by CPI
  • GCONSUM - The real per capita growth rate of nondurable goods and services is defined as the quarterly real per capita growth of personal consumption expenditures for nondurable goods and services
  • GIP - The growth rate of industrial production is defined as the percent of quarterly change in industrial production.
  • UI - Unanticipated inflation is the difference between the realized inflation rate during period t and the expected inflation rate at the beginning of the same period t."

Footnotes

  1. Cline P. B. 2004
  2. Ramady M. A. 2013
  3. Zhivetin V. B. 2007
  4. Ramady M. A. 2013
  5. Zhivetin V. B. 2007
  6. Ling D. C., Naranjo A. 1997

References

Author: Joanna Pawlik