Risk Management Q&A: What does proper risk-return analysis mean?

Risk Management Q&A Forum

What does proper risk-return analysis mean?

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Risk-return analysis means that for any each new project / decision, but also for the organization as a whole, you embed the following principles:

Identify what is the expected return. This can be the economic return but also intangible benefits / social return
Identify and measure all the risks of deviating from the expected outcome. For example the risk of large financial losses.
Combine 1. and 2. into metrics that capture the risk-adjusted opportunity as opposed to a pure anticipated revenue opportunity
Embed 3 into the incentives of all internal agents

Proper risk-return management means to do all the above with adequate safeguards for intrinsic limitations and gaming/abuse. For example agents may have incentives to minimize the severity of the risk profile, hence the risk assessment should be done independently.