As Warren Buffet famously said: "When the economic tide goes out, you find out who is swimming naked." Certainly the financial upheaval of the last two years has revealed a number of inadequately clad investors.
Just as every crisis prompts soul-searching about assumptions and standard procedures, banks and other financial institutions are taking a serious look now at how they measure, price and monitor risk in the capital markets. As Washington policymakers debate reforms to address regulatory gaps revealed by the worst crisis since the Great Depression, there is growing discussion about what are the right lessons to be drawn about managing financial risk.
L. Wendell Licon, a W. P. Carey Clinical Assistant Professor of Finance, says many of the lessons learned are the same as those gleaned from previous crises. The problem, he says, is that investors get caught up in the "irrational exuberance" of rising markets and forget fundamental risk management principles. "There are basic points: don't ignore remote possibilities; do your own risk analysis: if you don't know how to price a security, then you probably shouldn't buy it; and understand both the risks and benefits of the herd mentality in investing."
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