MODULE 02

Statistical Concepts related to Risk Management

Risk management is the process of identifying, assessing and controlling threats

to an organization's capital and earnings. These risks stem from a variety of

sources including financial uncertainties, legal liabilities, technology issues,

strategic management errors, accidents and natural disasters.

Some risks can be measured reasonably well. For those, risk can be quantified

using statistical tools to generate a probability distribution of profits and losses.

Other risks are not suitable for formal measurement but are however important. Risk

that can be measured can be managed better.

In simple terms, statistical forecasting implies the use of statistics based on historical data

to project what could happen out in the future. This can be done on any quantitative data:

Stock Market results, sales, GDP, Housing sales, etc

Forecasting is a technique that uses historical data as inputs to make informed estimates that

are predictive in determining the direction of future trends. Businesses utilize forecasting to

determine how to allocate their budgets or plan for anticipated expenses for an upcoming period

of time. This is typically based on the projected demand for the goods and services offered.
FORECASTING METHODS
 Forecasting methods can be broadly classified into:

1. Qualitative Methods – These methods are based on emotions, intuitions, judgments, personal

experiences, and opinions. This means that there is no math involved in qualitative forecasting methods.

Delphi Method, Market Survey, Executive Opinion, Sales Force Composite are part of this type of

forecasting.

2. Quantitative Methods – These methods depend wholly on mathematical or quantitative models. The

outcome of this method relies entirely on mathematical calculations. Time Series and Associative Models are

a part of this type of forecasting.

#1 – Delphi Method
Several rounds of questionnaires are sent out to the group of experts, and the
anonymous responses are aggregated and shared with the group after each
round. The experts are allowed to adjust their answers in subsequent rounds,
based on how they interpret the “group response” that has been provided to
them. Since multiple rounds of questions are asked and the panel is told what
the group thinks as a whole, the Delphi method seeks to reach the correct
response through consensus.
The questionnaires are returned to the facilitator, who groups the comments and prepares copies of the
information. A copy of the compiled comments is sent to each participant, along with the opportunity to
comment further.
At the end of each comment session, all questionnaires are returned to the facilitator, who decides if
another round is necessary or if the results are ready for publishing.
The questionnaire rounds can be repeated as many times as necessary to achieve a general sense of
consensus.
Advantages of the Delphi Method
 The Delphi method seeks to aggregate opinions from a diverse set of experts, and it can be done without
having to bring everyone together for a physical meeting. Since the responses of the participants are
anonymous, individual panelists don’t have to worry about repercussions for their opinions. The anonymity
of the participants also helps prevent the “halo effect,” which sees higher priority given to the views of more
powerful or higher-ranking members of the group.
 The "halo effect" is when one trait of a person or thing is used to make an overall judgment of that
person or thing.
 By conducting Delphi studies, consensus can be reached over time as
opinions are swayed, making the method very effective. In contrast with
many other types of interviews and focus groups, Delphi studies allow
participants to rethink and refine their opinions based on the input of others,
contributing to a more reflective and thoughtful process
 MARKET SURVEY

Definition: Market Survey is another most widely used sales forecasting method which is
used to gather information related to the market that cannot be collected from the company’s
internal records or the external published sources of data.
 The market survey method is typically employed in the situations where the primary data
or first-hand data is required to forecast the demand. Such situation exists when the
company wants to introduce a new product or a new variant into the market; then it
resorts to the primary data.
 Similarly, the company entering into a new business relies on the market survey to
forecast its demand or sales. Since, there are no past records available with the firm, so it
has to collect information from the market or from the customers directly to forecast the
sales. Usually, the companies conduct the survey among the sample of consumers to
understand their purchasing capacity, attitudes and purchasing habits.
 Survey of Expert’s Opinions
 Definition: In Survey of Expert’s Opinions, the specialized group of people in the
concerned fields, from both inside and outside the organization, are approached and
asked to give their opinions on sales trend.
 The expert’s opinions method is used when the organization wants the forecast to be
more accurate and which holds true for the entire industry. This is only possible
through the group of experts who have the complete information on the overall
economic environment and the conditions prevailing in the industry. Hence, people
from outside the organization, who are very close to the market are approached and
are required to sit with the company’s executives and reach to the final forecast.
 The Survey of Expert’s Opinions gives due weights to the experience and expertise of
people who know the market and the firm. This method, when employed successfully
can give accurate forecasts.
 But however, this also suffers from the demerits. Firstly, the experts from outside may
be reluctant to give the complete information about the conditions prevailing in the
industry. Secondly, the discussions could be biased that may result in false
predictions. Thirdly, the responsibility to take decisions is distributed on all and hence no
single person could be held responsible in case the forecast proves to be
wrong. Finally, a general forecast is made and could not be readily broken down into the
product-wise, month-wise and department-wise forecasts.
 Salesforce polling: In this method, the forecast is done based on the
opinions of salespeople who have steady interactions with the clients. As
they are closest to the customers, they can better predict the requirements
of the customers for the future market. The main advantage of this
forecasting method is that it is very simple to use and understand. The
information can be segregated easily into different categories. But the
drawback is that the salespeople can be either optimistic or pessimistic
about their predictions and this could lead to inaccurate forecasting.
Quantitative Forecasting Methods
 Quantitative techniques of forecasting are appropriate in project situations where
measurable, historical data is available and is usually used in forecasting for the
short or intermediate time frames. These techniques can be classified into two
broad categories:
 Time series analysis
 Causal methods
Time Series Analysis
 Time Series Models
Time series models look at historical data and identify patterns in the past data to arrive at a point in
the future based on these historical values. Since the historical data has a pattern, it becomes evident
that the data in the future should also have a pattern, and this method looks at cracking the pattern in
the future so that there is very little deviance from the actual calculations and the outcomes in the real
world. Below is the example of a time series model
Seasonal variations can be a component of a time series. These are periodic, short term, fairly
regular fluctuations in data caused by man-made or weather factors. The increase in demand for
candies during the Christmas season is an example of seasonal variations in data.
Cyclical variations in a time series are wave-like oscillations in data about the trend line and
typically have more than one-year duration. These variations are often caused by economic or
political factors.
Random variations are variations in data not accounted for by any of the previous components of
the time series. These variations cannot be easily predicted and are only after the fact. In
forecasting, these variations are accounted for as an error term.
The decrease in demand for a company's product due to a plant shutdown caused by a labor strike
is an example of a random variation in demand.
The term correlation is a combination of
two words ‘Co’ (together) and relation
(connection) between two quantities.
Correlation is when, at the time of study of
two variables, it is observed that a unit
change in one variable is retaliated by an
equivalent change in another variable, i.e.
direct or indirect. Or else the variables are
said to be uncorrelated when the
movement in one variable does not
amount to any movement in another
variable in a specific direction. It is a
statistical technique that represents the
strength of the connection between pairs of
variables.
  Correlation can be positive or negative. When
the two variables move in the same direction, i.e.
an increase in one variable will result in the
corresponding increase in another variable
and vice versa, then the variables are
considered to be positively correlated. For
instance: profit and investment, yield and
rainfall, study and marks
 On the contrary, when the two variables
move in different directions, in such a
way that an increase in one variable
will result in a decrease in another
variable and vice versa, This situation
is known as negative correlation. For
No correlation – weight
and energy , age and instance: Price and demand of a product ,
intelligence etc speed and travel time, age and eye vision.
A statistical technique for estimating the
change in the metric dependent variable
due to the change in one or more
independent variables, based on the
average mathematical relationship
between two or more variables is known
as regression. It plays a significant role
in many human activities, as it is a
powerful and flexible tool which used to
forecast the past, present or future events
on the basis of past or present
events. For instance: On the basis of
past records, a business’s future profit
can be estimated.
 Representation Ex : Average marks will
represent the marks of all the students in the
class.
Per capita income will reflect the income of
the whole country.

Comparison: Compare the marks of students