The Three P's of Total Risk Management

Current risk-management practices are based on probabilities of extreme dollar losses (e.g., measures like Value at Risk), but these measures capture only part of the story. Any complete risk-management system must address two other important factors—prices and preferences. Together with probabilities, these compose the three P's of “Total Risk Management.” This article describes how the three P's interact to determine sensible risk profiles for corporations and for individuals—guidelines for how much risk to bear and how much to hedge. By synthesizing existing research in economics, psychology, and decision sciences and through an ambitious research agenda to extend this synthesis into other disciplines, a complete and systematic approach to rational decision making in an uncertain world is within reach.