Risk Modeling- Importance Approaches and Decision-Making in Organizational Risk Management

Risk Modeling- Importance Approaches and Decision-Making in Organizational Risk Management

Introduction

Risk modeling has become an integral aspect in both the public and private sectors. It is highly regarded in critical organizational areas such as the financial facets to optimize business functionalities. Risk modeling plays a crucial role in addressing operational, strategic, geopolitical, and compliance risks. Its tremendous growth has been facilitated by the vast presence of information and sophisticated analysis capabilities in the modern era. Risk modeling is expected to expand in the future, creating the need for its detailed analysis. This document features the concept of risk modeling, its importance, approach to modeling, and organizational decisions in modeling, measuring, and aggregating risks.

The Concept of Risk Modelling

The concept of risk modeling revolves around the idea of simulating and quantifying risks (Franzetti, 2016). It is classified as a crucial subtask in financial modeling and thus articulates economic techniques to a great extent. The data analytics in risk modeling is significantly supported by the dynamic data visualization tool and the big data. These components foster the mathematical representation of a system by incorporating probability and distributions. Mahmoud (2020) explains that it is relatively hard to accurately predict risk occurrence using historical data. For this reason, risk modeling adopts expert elicitations from specialists in a specific field to support the prediction of risk occurrence and its possible severity. This approach has notably boosted modeling precision in the long run.

Various companies have different views on how to perfectly integrate a risk model into Enterprise Risk Management (ERM) strategy. Firms with mature ERMs seem to be in a better position to incorporate their designated risk models. They have developed strategic hubs termed Risk Analytics Sharing Centers (RASC) to store and maintain risk information (Spacek, 2021). The RASC is then connected to the available forms of business intelligence and primary data set as a tactical way of providing a dynamic view of risks. The major risks analyzed through risk modeling include market risk, operational risk, and credit risk. Therefore, each organization blends the most suitable risk model as per its needs and requirements.

Importance of Risk Models

Risk modeling has become a pivotal pillar in planning for unforeseeable events and reinforcing communication with stakeholders and organizations (Elliott & Villegas, 2019). Venturing into a new project requires adequate insights into the expected circumstances. As a result, it helps create a risk register of potential scenarios and consequently develops the countermeasures for better outcomes. On the other fold, risk modeling fosters communication by ensuring that the executives, management team, and other stakeholders are aware of the expected risks. This approach reduces future conflicts, which could potentially be based on key decisions made during the risk planning phase. It is always essential to uphold proactive rather than reactive remedies.

In addition, risk modeling contributes to the likelihood of fulfilling expectations and increases a company’s risk maturity (Spacek, 2021). Being on the top risk maturity ladder ascertains that a business is incredibly competent in a market saturated with risk-immature firms. This achievement is made possible by defining roles and assigning responsibilities to evade blame games if a risk materializes. A well-structured risk model ensures that a business runs on the required budget and at the right time. The accurate estimates eliminate the potential obstacles making the realization of organizational goals and objectives faster. As such, risk modeling is exceptionally essential in the corporate world.

An Approach to Modelling Various Risks

Simulation seems as the best-fit approach to modeling various risks. As already stated, these risks might pertain to market, operation, liquidity, or credit. A simulation would perfectly match these needs by identifying how a model responds to particular assumptions. This mechanism is vital in amassing insights into the underlying process to make it more resilient. The results obtained from the simulation are then used to adjust the model to become more competent in the long run. The obtained outcomes are applied to enhancing business sustainability by guiding the implementation of sensible decisions relevant to risk.

An effective simulation degrades the complexity of risk and makes it easy to institute crucial decisions (Williams & Jin, 2018). It provides a detailed insight into how a model will behave in specific conditions increasing confidence and comfort in decision making. This perspective eliminates surprises and disappointment that would otherwise emerge. Simulation allows a degree of flexibility in that a process can always be adjusted, giving control over a decision’s outcomes. Its inclusion should be grounded on a clear vision from the executives and an outright definition and allocation of roles. However, simulation should not be perceived as an auto-decision maker but rather as a guide. Its applicability and relevance in modeling various risks are invariably meaningful in a business operation.

Making Decisions about Techniques to Model, Measure, and Aggregate Risks

Organizations may make decisions about techniques to model, measure, and aggregate risks from three perspectives, namely bottom-up, top-down, or mixed approach (Abubakar et al., 2019). The bottom-up technique involves decision-making from the lower management levels. The managers are given the power to discuss and agree on the most feasible mechanisms for handling risks. The employees are also engaged to ensure their contributions account for the final decision. It promotes teamwork and ensures that the agreed models and measures are in the organization’s best interest. It is highly recommendable as it involves diverse inputs from different groups.

The top-down approach is quite centralized, and thus the decisions are proposed and implemented by the executives. They come up with the appropriate models, measures, and aggregate risks that serve the organization in the best way possible. This methodology is typically referred to as the command and control technique as it adopts a hierarchal operation model. It eliminates ambiguities and fosters clarity as only a few people are included in the decision table. Its swiftness greatly supports its suitability in addressing issues. Therefore, it can be a good choice to rush decisions.

The mixed approach is simply the combination of bottom-up and top-down decision-making techniques. It involves a collaboration between the managers and executives to deliver the best models, measures, and aggregate risks. The combined effort equally results in quality and reliable decisions pertinent to an organization. It requires commitment and coordination among the involved parties to draw a meaningful conclusion.

Conclusion

The concept of risk modeling is founded on a mathematical representation of probability and distribution of risk. Its application in organizations has gained momentum due to the ever-varying nature of the business environment. Risk models are essential as they enable planning, communication, risk maturity, and readiness to handle risks. Simulation is effective in modeling diverse risks within a company. Organizational decisions on risk modeling can be made through the bottom-up, top-down, or combined approach. The relevance and applicability of risk modeling are projected to expand steadily in the future as technology grows.

 References

Abubakar, A. M., Elrehail, H., Alatailat, M. A., & Elçi, A. (2019). Knowledge management, decision-making style, and organizational performance. Journal of Innovation & Knowledge, 4(2), 104-114.

Elliott, M., & Villegas, S. (2019). Consider the Importance of Risk Communication. Journal – American Water Works Association, 111(12), 64-66. https://doi.org/10.1002/awwa.1416

Franzetti, C. (2016). Operational risk modeling and management. CRC Press.

Mahmoud, S. (2020). Corporate Risk Modelling Using the Analytic Hierarchy Process. Available at SSRN 3701114.

Spacek, M. (2021). Business Process Risk Modelling in Theory and Practice. Quality Innovation  Prosperity, 25(1), 55-72.

Williams, E. A., & Jin, Y. (2018, April). Use of situation and risk modeling in guidance solutions. In 2018 IEEE/ION Position, Location and Navigation Symposium (PLANS) (pp. 516-521). IEEE.

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Your task this week is to write a research paper discussing the concept of risk modeling. Please also evaluate the importance of risk models. Lastly, construct an approach to modeling various risks and evaluate how an organization may make decisions about techniques to model, measure, and aggregate risks.

Risk Modeling- Importance Approaches and Decision-Making in Organizational Risk Management

Your paper should meet the following requirements:
Be approximately FOUR to SIX pages in length, not including the required cover page and reference page.
Follow APA7 guidelines. Your paper should include an introduction, a body with fully developed content, and a conclusion.
Support your answers with the readings from the course and at least two scholarly journal articles to support your positions, claims, and observations, in addition to your textbook.
Be clearly and well-written, concise, and logical, using excellent grammar and style techniques. You are being graded in part on the quality of your writing.