Risk, in the most basic sense, is the possibility that bad things might happen. Humans evolved to manage risks such as wild animals and starvation. However, our risk awareness is not always suited to the modern world (as anyone who has taught a child to cross the road knows). Behavioral science shows that we rely too much on instinct and personal experience, as biases skew our thought processes. Furthermore, even the way we frame risk decisions irrationally influences our willingness to take risk.

 

Even so, surprisingly sophisticated examples of risk management can be seen in early history. In ancient times, merchants and their lenders shared risk by tying loan repayments to the safe arrival of shipments using maritime loans (i.e., combining loans with a type of insurance). The insurance contract separated from the loan contract as early as the fourteenth century in northern Italy, creating the first standalone financial risk transfer instrument.

 

From the seventeenth century onward, a more methodical approach to the mathematics of risk can be traced. This was followed by the development of exchange-based risk transfer in the form of agricultural futures contracts in the eighteenth and nineteenth centuries (Figure 1.2). That methodical approach continued to evolve in the twentieth century and beyond, with major advances in financial theory in the 1950s; an explosion in risk management markets from the 1970s onwards; and the emergence of new instruments, such as cyber risk insurance, in the early twenty-first century. Risk management is an old craft but a young science—and an even younger profession. How we think about risk is the biggest determinant of whether we recognize risks, assess them properly, measure them using appropriate risk metrics, and succeed in managing them. 

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Most risk management disasters are caused by failures in these fundamental building blocks, rather than the failure of some sophisticated technique. Centuries-old financial institutions have been bankrupted because their risk management procedures ignored a certain type of risk, misunderstood connections between risks, or did not follow the classic steps in the risk management process.

 

Have an eye on risk timeline as mentioned below.