One aspect of operational risk that is often missed is the effects on banks of a pandemic. This is just the sort of “long tail” statistical event that VaR modelling will miss. As happened with the SARS epidemic in South-East and East Asia a few years ago, a contageous disease outbreak will cause some very unusual effects. How would your bank or company cope with a serious influenza pandemic, for example?
A simulation being run over the next few months in London is a good step towards ensuring that a pandemic is not going to completely cripple the financial system, multiplying what would have been a serious problem, with tragic effects for those directly affected, into a global crisis.
The assumptions behind these sorts of simulations are fairly simple:
- A reasonably large, but not overwhelming, number of people actually catch the disease. It may only be 1% of the population;
- The disease is known, or suspected, to be airborne and easy to catch;
- The disease causes at least a few fatalities; and
- People tend to react more strongly to the risk than strict logic would indicate.
These sorts of scenarios can severly try a financial system, as crucial people stop turning up to work – because they, or a family member are already sick or to try to avoid catching the illness. Many may be able to continue at least part time work from home – unless they themselves are sick – and this should limit the effects, but having a clearly established plan, some procedures and running a simulation or two would not be unwise.
The important thing to remember is that the number of people who actually get sick may be small, but the effects of assumption 4 mean that the results of the illness is multiplied for the duration of the crisis.
Trying to force your employees into work while a pandemic is on would be tricky.
5 comments
30 September, 2006 at 12:58
penguinunearthed
I’ve done a bit of work on pandemic modelling. In 1918, absenteeism in cities in the US where the pandemic was in full force was around 40%. And this is for a disease where about 25% of the population caught it, and about 1-2% of those people died.
So there are a lot of assumptions to make about things you might not quickly think of – credit risks will be higher as tourism organisations get into difficulties, fund management products will probably have high redemptions as people take their money out of equities and into cash, and, of course, you’ll have to run the company with half the staff.
Interesting stuff.
30 September, 2006 at 19:57
ozrisk
Penguin,
Do you have a link to the research? I would be interested to see how it unfolded.
30 September, 2006 at 20:54
penguinunearthed
Actually I got that stat from a book (here’s a link to my review):
http://penguinunearthed.wordpress.com/2006/04/08/book-review-the-great-influenza/
but here is the best summary paper I have seen on the topic (chock full of links, too):
http://www.actuaries.asn.au/IAA/upload/public/fsf06_paper_stitt_pandemic.pdf
1 October, 2006 at 00:11
ozrisk
Thanks for that – I will go and get the book. The reviews certainly make it worth looking at.
The spam filter got your comment(s), so I deleted one as they were identical.
9 October, 2006 at 13:42
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