Risk Types
Humans love to classify and categorize, so we have defined a number of risk types.
Health Risk
The risk of ill-health (both emotional and physical), including loss of life
Relationship Risk
The risk of emotional damage due to the failure of a relationship
Environmental Risk
The risk of damage to the environment
Natural Disaster Risk
The risk to people and property due to acts of nature
Reputation Risk
The risk of embarrassment or loss of respect by people whose opinion is valued
Market Risk
The risk of market prices or values moving in an unfavorable direction
Credit Risk
The risk of loss that arises when a person or corporate entity fails to fully pay financial obligations, including principal and interest owed
Operational Risk
The risk of loss or damage due to errors by people or flaws in processes. Operational risk also includes instances of fraud
Political Risk
The risk of loss or damage due to adverse government regulations, regime changes, war
Legal Risk
The risk of loss due to legal liability
Strategic Risk
The risk of loss or damage due to poor decision making pertaining to important future plans
Counterparty Risk
The risk that a counterparty to a contract or agreement will not live up to its obligations
Concentration Risk
The risk inherent in proverbially “putting all eggs in one basket”
Model Risk
The risk of using a flawed model, yielding incorrect outputs
Education Risk
The risk that educational material will be erroneous or educational methods inefficient
Risk Classification
While it’s appealing to try to compartmentalize risks into individual classifications, it should be clear these distinctions are often arbitrary and not mutually exclusive. For example, political risk inherent in a country’s decision to go to war may very quickly affect pending legal rulings (legal risk), business continuity plans (operational risk), and the health of people caught in the ensuing conflict (health or physical risk). Thus, it’s not clear precisely where one risk ends and another begins.
It’s important to define whose perspective is being considered for a given risk. For example, when an employee attempts to defraud a firm, the criminal’s perspective is that he faces legal risk, while the firm faces operational risk. From a risk-return perspective, the criminal hopes to make money from taking the risk; from the firm’s perspective, it’s not about making money, but avoiding the loss of money.
Some of these risks we explicitly think about (and take action against), others are implicit (we know they are there but don’t really do anything about them—e.g., we’ll walk in a neighborhood that is considered dangerous, or stay invested in something that could be considered precarious), and yet others we don’t think of or even realize are there (the likelihood that a brick will fall off a nearby roof and hit us on the head).