The Known, the Unknown, and the Unknowable in Financial Risk Management: Measurement and Theory Advancing Practice

By Francis X. Diebold; Neil A. Doherty et al. | Go to book overview

1. Introduction

Francis X. Diebold, Neil A. Doherty, and Richard J. Herring

Successful financial risk management requires constant grappling with the known, the unknown and the unknowable (“KuU”). But think of KuU as more than simply an acronym for “the known, the unknown, and the unknowable”; indeed, we think of it as a conceptual framework. We believe that “KuU thinking” can promote improved decision making—helping us to recognize situations of K and u and U and their differences, using different tools in different situations, while maintaining awareness that the boundaries are fuzzy and subject to change.

Perhaps the broadest lesson is recognition of the wide applicability of KuU thinking, and the importance of each of K and u and U. KuU thinking spans all types of financial risk, with the proportion of uU increasing steadily as one moves through market, credit, and operational risks. In addition, KuU thinking spans risk measurement and management in all segments of the financial services industry, including investing, asset management, banking, insurance, and real estate. Finally, KuU thinking spans both the regulated and the regulators: regulators’ concerns largely match those of the regulated (risk measurement and management), but with an extra layer of concern for systemic risk.


1.1. KNOWLEDGE AS MEASUREMENT, AND KNOWLEDGE AS THEORY

Knowledge is both measurement and theory. Observed or measured facts about our world have no meaning for us outside our ability to relate them to a

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