BNY Mellon and Investor Analytics (IA), a New Jersey-based provider of the risk management services, have jointly, conducted a study on risk management. It has been demonstrated that traditional economics does not adequately describe real markets and the potential impacts on financial portfolios.

Reportedly, the study entitled ‘Tomorrow’s Risk Management: How behavioral economics, cognitive studies and complexity science add up to more than their own sum’ recommends that risk managers explicitly incorporate lessons of known human biases into market stress tests and scenarios. Additionally, the study reveals several such biases together with specific recommendations on how to use that information for better analysis.

The bank has stated that in surveying the fields of behavioral economics, cognitive studies and complexity science, the study highlights include: humans are risk averse when it comes to gains, but risk takers when it comes to losses; more credibility is given to stories or scenarios that are rich in detail, even though these tend to be statistically less probable to happen and rather than diminishing with improved efficiency, volatility is actually a necessary component for markets to exist in the first place and does not change with efficiency.

David Aldrich, head of alternative investment services EMEA at BNY Mellon, said: “With the apparent breakdown of traditional risk management and market analysis to provide meaningful assistance in the run up to and during the recent financial crisis, these new fields offer a thought-provoking perspective. We believe firmly that risk management will look very different going forward and will provide enhanced analytics for practitioners to analyse risks within their portfolios.”

Damian Handzy, chairman and CEO of IA, said: “This report highlights the critical need for managers, investors and risk professionals alike to take a fresh look at how they are determining risk in their portfolios by incorporating not just the fact that we are ‘irrational’ decision makers but actually incorporating the very ways in which we are irrational in making our decisions. This is paramount if we are to improve our understanding of markets and their inherent risks.”