Crisis risk and risk management

• Published date: 01 November 2023
• Author: René M. Stulz
• Date: 01 November 2023
• DOI: http://doi.org/10.1111/eufm.12441

DOI: 10.1111/eufm.12441

ORIGINAL ARTICLE

Crisis risk and risk management

René M. Stulz

Fisher College of Business at The Ohio

State University, Columbus, Ohio, USA

Correspondence

René M. Stulz, Fisher College of Business

at The Ohio State University, NBER, and

ECGI, Columbus, OH, USA.

Email: stulz@cob.osu.edu

Abstract

We assess the state of knowledge about crisis risk and

its implications for risk management. Data that became

available after the global financial crisis show that

some types of crises are predictable when accounting

for interactions between risks. However, other types of

crises do not seem predictable. There is no evidence

that the frequency of economic and financial crises is

increasing. While data show that an economic crisis is

more likely following a political crisis, there is no

comparable evidence for climate events. Strategies that

increase firm operational and financial flexibility

reduce the adverse impact of crises on firms.

KEYWORDS

crisis risk, financial crisis, risk management

JEL CLASSIFICATION

G01 Financial Crises: G. Financial Economics, G21 Banks,

Depository Institutions, Micro Finance Institutions, Mortgages:

G2 Financial Institutions and Services: G. Financial Economics,

G32 Financing Policy, Financial Risk and Risk Management,

Capital and Ownership Structure, Value of Firms, Goodwill:

G3 Corporate Finance and Governance: G. Financial Economics

Eur Financ Manag. 2023;29:1377–1400. wileyonlinelibrary.com/journal/eufm

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This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

© 2023 The Authors. European Financial Management published by John Wiley & Sons Ltd.

Prepared for the NYU VRI conference on “Managing Compound Risks in a Polycrisis World.”I am grateful for

comments from Richard Berner, Harry DeAngelo, Leandro Sanz, and Til Schuermann, as well as from the conference

participants.

1|INTRODUCTION

Since the 1990s, much progress has been made in identifying, measuring, and monitoring risks.

Armed with these identification, measurement, and monitoring tools, firms can make decisions

about what risks to take, what risks to avoid, and what risks to mitigate. We call risk

management the process of identifying, measuring, monitoring, and managing risks. Despite

this progress, some observers argued both during and after the global financial crisis (GFC) that

risk managers failed to anticipate and prepare for the crisis. These observers were generally not

convinced by the argument of the Economics Nobel prizewinner Robert Lucas that, because

markets are efficient, “The best and only realistic thing you can do in this context is to keep

your eyes open and hope for the best.”

1

The last few years have heightened this concern about

how risk managers should deal with crisis risk as the COVID‐19 crisis appeared to be the

ultimate black swan event. Most recently, there has been much discussion that we are entering

a“new epoch of crisis,”

2

that we are in a polycrisis or may be facing the heightened risk of a

polycrisis. In short, a polycrisis is a situation where multiple crises are occurring at close to the

same time and they are feeding on each other so that the adverse impact of a polycrisis is worse

than the adverse impact of the sum of the individual crises. In this paper, we assess the current

state of knowledge about crisis risk and draw some implications for the practice of risk

management. This paper is not a review of the literature as excellent reviews already exist.

3

To understand crisis risk, we need to define what a crisis is. A frequent definition is that a

crisis is a tail outcome in a distribution. For instance, for growth of GDP per capita, a crisis

could be an outcome that has less than a 1% chance of occurring given the historical

distribution of GDP per capita growth. This definition is incomplete. If extreme outcomes are

not qualitatively different from less extreme outcomes, there is no good reason to focus on these

extreme outcomes separately from focusing on the whole distribution of outcomes. Studying

crises makes sense as a separate topic of study if the economy or critical parts of the economy

function differently in a crisis than in noncrisis or normal times. A good analogy is a car engine.

The engine can work at low speeds or high speeds. However, if a crucial component of the

engine is broken, the engine stops working normally and no longer performs its function. If the

engine has a low speed, pressing on the accelerator will solve the problem. However, that

approach will be useless if a key component is broken. If a crisis means that the financial

markets do not function normally, then the financial policies a firm has put in place that rely

on financial markets functioning normally will not work and the firm will need a different set

of financial policies to deal with a crisis. We will define a crisis as a tail outcome for the

economy such that there are important disruptions in the functioning of the economy or of

critical parts of the economy.

Much effort has been spent in economics and finance to construct global databases of crises

since the GFC. Global databases are required for statistical analysis because crises are too rare

at the country level. Some of these databases rely on quantitative definitions of crises, while

others use narrative definitions. We want to focus on crises that affect the whole economy

rather than crises that affect specific industries or specific sectors of the economy. For crises

that affect the whole economy, there are two broad approaches that have been followed to

construct databases. One approach identifies instances where there is a sharp drop in economic

1

“In defense of the dismal science,”by Robert Lucas, The Economist, August 6, 2009.

2

“The slow‐motion tidal wave consuming our economy,”by Richard Bookstaber, The New York Times, March 27, 2023.

3

See, for instance, Claessens and Kose (2013) and Sufi and Taylor (2022), for reviews of the literature on financial crises.

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