Market events over the past year have shown that traditional economics does not adequately describe real markets and the potential impacts on financial portfolios, according to a new study released by BNY Mellon and Investor Analytics.

The thought-provoking study, “Tomorrow’s Risk Management: How behavioral economics, cognitive studies and complexity science add up to more than their own sum,” recommends that those managing risk – whether asset owners or asset managers – incorporate lessons of known human biases into market stress tests and scenarios.

Some highlights:

- Humans are risk averse when it comes to gains, but risk takers when it comes to losses;
- More credibility is given to stories or scenarios that are rich in detail, even though these tend to be statistically less probable to happen;
- Rather than diminishing with improved efficiency, volatility is actually a necessary component for markets to exist in the first place and does not change with efficiency

The report conveys the need for managers, investors and risk professionals to take a fresh look at how they determine risk in their portfolios by incorporating not just the fact that we are ‘irrational’ decision makers, but the very ways in which we are irrational in making our decisions.


To read the report in full, please click here