Calculated Risk

The term «risk» is an entire science in the world of finance. Banks and insurance companies need mathematical models to cope with the increase in business arising from modern financial products, such as options or share funds. And methodic knowledge from the universities is more needed than ever. In 1994 this trend led to the creation of «RiskLab» at the ETH Zürich; a think-tank where theoreticians and practitioners come together to mathematically analyze financial risk.

«How much money will we have made by the end of the day and with what probability? Or lost?» These are the questions that increasingly occupy the minds of fund managers at financial institutions. With the advent of new financial instruments, information on the global markets more quickly available, and new risk structures, the business of finance has become ever more complex.

This was one of the reasons for two professors at the Swiss Federal Institute of Technology in Zurich (ETH) to found RiskLab within its Department of Mathematics. «RiskLab» guarantees an innovative form of collaboration: here, practitioners and mathematical scientists come together to split hairs. «We're a research centre where methodical knowledge of mathematics, insurance and finance mathematics are brought together, and we have our say when it comes to practical matters» is the way Hans-Jakob Lüthi und Paul Embrechts put it, on whose initiative RiskLab was founded.

Preceding this event, a director of one of the big Swiss banks had knocked on the door and suggested tying the competencies of the university and the world of finance together. In 1994 «RiskLab» was created and moved into its own quarters at the ETH Zurich with sponsorship from the Credit Suisse Group, the Swiss Bank Corporation and the Union Bank of Switzerland (the latter two later merged to form UBS). A little later, they were joined by the reinsurance company Swiss Re, while Freddy Delbaen, professor of mathematical finance at the ETH Zurich, completed the group of academics.

«RiskLab's» research activities are devoted, among other things, to a better understanding of risk using quantitative models. Its goal is to develop practical risk measurements based on a few well-chosen core activities of the market, such as interest rates, share prices, exchange rates or commodity prices. «We want to be able to predict what influence all market components have on a company's investment portfolio» explains Paul Embrechts. In addition, such a risk measurement system should help fund managers to gauge their risk exposure. It would also give insurance companies a better way of predicting certain risks, «say, the risk of hail damage to cars». As Hans-Jakob Lüthi puts it: «At RiskLab we want to make the area of risk more visible in the landscape and provide finance companies with sophisticated instruments to help them to decide which risks to enter into and which they should try to avoid».

Other projects being carried out at «RiskLab» are concerned with fair pricing, and questions which arise from the liberalisation, for example, of the telecommunication sector or electricity providers. Freddy Delbaen explains: «If an electricity company sells options at a fixed price or if a telecommunication company gives a customer a contractual guarantee of fixed access to the network, then the provider needs re-insurance. And one must have appropriate finance mathematical instruments to determine and weigh all relevant factors» he says.

In the near future, RiskLab will be complemented with competences in the field of economics because interest in its work is growing outside academia. Lüthi, Embrechts und Delbaen envision a firmly-established centre at the ETH Zurich with the participation of other departments of the ETH and other universities. «There are very few fields of research where academic and economical interests have so much in common as they have at RiskLab» say the professors, «and the possibilities of collaboration are truly fascinating».

«Spreading» over the border

RiskLab's success has already led some institutions outside Switzerland to establish their own risk research units. It does not bother the ETH professors that these have even gone as far as to call them «RiskLab». «Our only aim in this regard is to make sure that Zurich remains a centre of competence» they all agree.


Further information:

Fokus Research, Zürich, November 1999. (Translation commissioned by RiskLab, links set by RiskLab)
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