Risk Appetite Theory

893 Words4 Pages
This work investigates the factors that influence firms’ risk appetite (the amount of risk that a firm is willing to accept) and, in particular, focuses on the characteristics and functioning of the board. The first chapter includes the analysis of the literature regarding risk, risk components and risk definitions. The first question that this chapter tries to answer is “what is risk?”. There is no general agreement on the definition of risk, but the ISO 31000 (2009) defines risk as “the effect of uncertainty on objectives”, where uncertainties in this definition include events (which may or may not happen) and uncertainties caused by ambiguity or lack of information. Another comprehensive definition of risk is the one developed by Crowe…show more content…
Two main models are identified: the risk pyramid, by KPMG (2010), a simple model, and RARA model developed by Hillson and Murray-Webster (2011), a more complex model. The KPMG simpler model identify the risk capacity as starting point for risk definition. Given this starting point, the second step is identifying the risk appetite, and thus, developing the strategic goals whit aggregate risk levels. The third step is setting the risk tolerance, the risk appetite correlated to each risk category. The fourth step is setting the risk target, or risk tolerance correlated to business plan and metrics. Fifth, and last, step is setting risk limits, or risk targets correlated to controls at the process level. The Hillson’s and Murray-Webster’s (2011) RARA Model, is actually three different models, in three different scenarios: unmanaged scenario, constrained scenario and informed scenario. In the most comprehensive scenario, the informed one, the authors identify three macro areas: input, mediating factors and outcomes. In inputs they put risk capacity, risk propensity, risk culture, inherent risk exposure and risk perception, in mediating factors, risk appetite and risk attitude and in outcomes risk thresholds. They identify that risk appetite is influenced by risk propensity and culture, risk attitude by risk perception (and a loop by risk actions and risk evaluation), risk thresholds by risk appetite, risk attitude and risk capacity. In the unmanaged scenario only risk capacity and objectives are present, while in constrained one, risk propensity and risk culture is
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