A Multi-objective Approach to Integrated Risk Management

The integrated management of financial risks represents one of the main challenges in contemporary banking business. Deviating from a rather silo-based approach to risk management banks put increasing efforts into aggregating risks across different risk types and also across different business units to obtain an overall risk picture and to manage risk and return on a consolidated level. Up to now no state-of-the-art approach to fulfill this task has emerged yet. Risk managers struggle with a number of important issues including unstable and weakly founded correlation assumptions, inconsistent risk metrics and differing time horizons for the different risk types. In this contribution we present a novel approach that overcomes parts of these unresolved issues. By defining a multi-objective optimization problem we avoid the main drawback of other approaches which try to aggregate different risk metrics that do not fit together. A MOEA is a natural choice in our multi-objective context since some common real-world objective functions in risk management are non-linear and non-convex. To illustrate the use of a MOEA, we apply the NSGA-II to a sample real-world instance of our multi-objective problem. The presented approach is flexible with respect to modifications and extensions concerning real-world risk measurement methodologies, correlation assumptions, different time horizons and additional risk types.