Running head: PSYCHOLOGY OF RISK MANAGEMENT 1 The Psychology of Risk Management Gaëlle Villejoubert and Frédéric Vallée-Tourangeau Kingston University Author Note Gaëlle Villejoubert, Frédéric Vallée-Tourangeau, School of Social Science, Kingston University, London. This is an Accepted Manuscript of a chapter published by Risk Books in Böcker, K. (Ed.), Rethinking Risk Measurement and Reporting: Uncertainty, Bayesian Analysis and Expert Judgement (Vol. I, pp. 405-435) on 8 November 2010, available online: https://riskbooks.com/rethinking-risk-measurement-and-reporting-volume-i-2. This manuscript may not exactly replicate the final version published in the book. It is not the copy of the record. Correspondence concerning this chapter should be addressed to Dr Gaëlle Villejoubert, School of Social Science, Kingston University, Penrhyn Road, Kingston upon Thames, KT1 2EE, UNITED KINGDOM. Email:
[email protected]., fax: +44 (0)208 417 2388 Running head: PSYCHOLOGY OF RISK MANAGEMENT 2 The Psychology of Risk Management Risk lies at the heart of the most common banking decisions. Large banks have retail, commercial, and investment banking operations. The nature and magnitude of the risks, and potential returns, vary considerably across these different operations. A general characterisation of risk involves two dimensions: the extent of harm caused by an adverse outcome (e.g., a bank run, a large commercial client declaring bankruptcy, significant fluctuations in the availability of credit) and the likelihood that this adverse outcome will occur (Breakwell, 2007). For the past two decades, major investment firms have managed those risks by using complex mathematical models for measuring risk in various portfolios. Those models were used to quantify risk positions, often in the form of a Value-at-Risk (VaR), which corresponds to the maximum potential loss that could be expected with a 99% or 95% probability.