Risk Management With Monte Carlo Analysis

Executives and managers are charged with achieving objectives, establishing programme outcomes, and/or delivering project outputs, all in the face of uncertainty. This uncertainty arises because they cannot know everything completely, such as:

• How long a task will take to complete

• Whether a competitor will gain a lead on them in the marketplace.

This lecture shows you how to:

1. Identify what is important in your business or other context; and

2. Differentiate between assumptions and risks.

It anchors these in a commercial business that has planned its five year growth strategy, showing the difference between the internal levers - such as sales growth, margin improvement, and back office efficiencies - and the risks that may strike the business.

This prepares the way to identifying the risks in the next section.

Here we introduce you to the working risk register that will enable you to see how risk management is done. The downloadable excel risk register includes Monte Carlo simulation using beginner level Excel arithmetic. This excel is in two versions: (.xlsx) is Excel 2016; (.xls) is Excel 97-201.

Risk managers seldom manage risk on their own.

Rather, they elicit the expertise and insights of their fellows into what is at risk in their context to arrive at an agreed statement of each risk, and the impact each risk is anticipated to have on what is at stake.

This lecture reviews some of the 31 techniques listed in ISO 31010, Risk management — Risk assessment techniques.

Many organisations prepare qualitative "heat maps" of their risk exposure.

In so doing, they describe risks using words such as "highly unlikely" and "moderate impact".

This lecture shows how to prepare a heat map with the risks identified for the business in the previous section. It then exposes the limitations of heatmaps and shows how the risks' impacts and probabilities may be quantified.

This lecture argues for quantifying risks as three-point estimates, as these are best suited to capturing the insights and expertise elicited from experts. It also shows:

1. How three-point estimates may be converted to triangular distributions of the probability of impacts;

2. How the three-point estimates for probability of occurrence and impact may be multiplied to compute the exposure of the enterprise to each risk.

This lecture shows how the risk register collects and processes the three-point estimates of risk impact and probability of occurrence. It shows the excel calculations and how the Monte Carlo simulation is performed. It also explains where to find an explanation of the underlying mathematics, although this is not required to use the risk register.

This lecture shows how the risk register calculates the aggregate risk exposure from the three-point estimates of risk impact and probability of occurrence across the Monte Carlo simulations. That is, it shows how the risk register:

• Constructs one scenario by computing the impact of each risk from its three-point estimates

• Aggregates the impacts of all risks

• Adds the aggregate to a histogram

• Then repeats for the next and all subsequent scenarios.

The lecture presents the resulting histogram of impacts and the key statistics that describe the aggregate risk exposure of the enterprise. The student will know how to interpret these statistics, and thus be ready to devise mitigations.

This lecture opens up the excel spreadsheet and shows how it performs the calculations presented in the previous lecture.

This lecture shows how the risk manager elicits mitigations from the experts and how the risk register calculates the residual risk exposure if they are all implemented.

This prepares the risk manager to present the mitigation options to the CEO and for the mitigation to be developed.

This video shows how the mitigations are entered in the risk register and how the spreadsheet calculates the residual exposure histogram and the key statistics.

It also shows how the risk manager would work with the CEO to decide which risk to treat and which to tolerate, based on the cost of the mitigations and the resultant risk exposure.

This demonstrates the power of the technique and the tool in supporting decision making. A heatmap can not deliver this level of support to decision making.

Once the mitigations have been selected and implemented, the risk manager continues to review both the risks and their mitigation. This lecture shows how Risk Management participates in Strategic Management.

This shows how the Monte Carlo Simulation techniques used in Risk Management can be used to forecast the free cash flow of a business in various scenarios, and to assess its net present value.