Depression, Sovereign Default Are Top Extreme Risks

Sovereign default has risen four places to second position in Towers Watson's ranking of the top fifteen extreme risks while depression retains the top position and hyperinflation moves to third.

 

The company's ranking categorises events that would have a high impact on global economic growth and asset returns if they occurred and incorporates the degree of certainty in assessing the risk.

 

The bottom three in the ranking are the end of fiat money, infrastructure failure (replacing a major global conflict which has moved up in the ranking) and a killer pandemic.

 

In the research entitled Extreme Risks - the 2011 update, Towers Watson has updated its likelihood and impact assessment to reflect the disappointing economic recovery in the developed world during the past two years which it believes increases the likelihood of further economic shocks.

 

Accordingly, it has moved sovereign default from ‘Medium’ impact to ‘High’ impact and recent developments – both economic and political – in the euro area suggest that a break-up of the euro is more likely, so it has moved this risk from ‘Very low’ to ‘Low’.

 

“The global economic environment continues to be characterised by significant imbalances and consequently is not in good shape to withstand any further major shocks," says Peter Ryan-Kane, Towers Watson's head of portfolio advisory for Asia Pacific.

 

The ranking lists a number of concerns that could disrupt the recovery and long-term economic developments and aims to help asset owners consider and manage their investment risk beyond the conventional VaR95 level.

 

"It should however be noted that even with the best analysis, we will not be able to anticipate all risks. While we have a list of 15 extreme risks, by definition they are ‘known unknowns’ and what might harm asset owners even more are the ‘unknown unknowns’. The important thing is to build our ability to adapt and learn, enhancing the resilience of the system,” underscores Ryan-Kane.

Since the first edition of Towers Watson's ranking, published in 2009, the company has added two new extreme risks resource scarcity and infrastructure failure (ranked11 and 14 respectively) which replace the end of capitalism and excessive leverage.

 

According to Towers Watson the concept of resource scarcity is broad and includes energy, metals, water or arable land. It assesses the likely mismatch between the linear evolution of the supply curves for finite resources and the exponential change in demand curves given population growth and increasing living standards.

 

It suggests that much of this increased demand is expected to come from the two most heavily populated countries - China and India - which have been experiencing very fast economic growth in recent years and are expected to maintain that pace going forward.

 

Meanwhile, infrastructure failure is the risk posed by the dependence of modern economies on computer networks and power grids. The cost of such a failure would rise exponentially the longer the networks remained un-operational.

 

Ryan-Kane notes that the wide use of computing technology means that all critical infrastructure networks, whether power plants or financial clearing systems, are vulnerable to security breaches and cyber attacks.

 

"The malfunction of a major infrastructure network for a relatively long period could severely disrupt human activity, threaten lives in critical facilities and raise the possibility of social unrest and law-breaking behaviours for survival,” he says.

 

The research suggests  that of all of the things to be considered, public policy issues should be a priority as they will both influence the risks and be shaped by the shifting likelihood of the different risks through time.

 

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