FRM Corner

The History of Risk Management: 30 Centuries of Innovation

From fair value to portfolio theory to EVT, VaR and the Basel accords, financial risk management has been shaped by threshold events for the past three millennia. Which of these defining moments have been the most impactful?

Friday, March 22, 2019

By Marco Folpmers


Fascinating events have radically altered the course of financial risk management for the past 3,000 years - starting with Homer's definition of value back in the 8th century B.C. and moving all the way through the post-crisis Turner Review of 2009. Since there are many transcendent thinkers and seismic events from which to choose, the pantheon of seminal moments for this discipline is highly debatable.

Marco Folpmers Headshot
Marco Folpmers

David Christian, the author of “Big History,” provides a template for evaluating historical events. In his book, Christian explains that there have been several “threshold” events (e.g., the Big Bang and the evolution of homo sapiens) that can be classified as defining moments in history.

Several books have been written on the history of financial risk management. One classic is Peter L. Bernstein's Against the Gods: The Remarkable Story of Risk. More recent thinking is well captured in Justin Fox's The Myth of the Rational Market. However, describing history in terms of thresholds is something new and requires some original thinking.

My personal list of FRM thresholds is captured in the table below.

Table: The Most Impactful Events in the History of Financial Risk Management

Threshold Nr

Threshold Proponent





Definition of value

8th century B.C.



Probabilistic thinking

16th century



Normal distribution

19th century



Portfolio theory and diversification



Kahneman & Tversky

Behavioral finance




Fat-tailed distributions and extreme value theory



Black & Scholes

Derivatives theory



Basel I accord

Comprehensive regulatory framework for risk and capital



The Jorion vs. Taleb debate

Merits and de-merits of Value-at-Risk



Basel II accord

Advanced approaches for credit risk, market risk and operational risk



The Turner Review and Basel III

Post-crisis strengthening of capital's quantity and quality



Going into detail for each threshold isn't feasible, because that would amount to writing a book. But I will elaborate on the first threshold.

Before expounding on Homer's definition of value, it is worthwhile to point out some peculiarities of the complete list. Obviously, this is a personal list that contains personal choices.

In my opinion, value-at-risk (VaR) is an extremely important concept, although its demerits should be acknowledged, and normal distributions shouldn't be assumed. What's more, I believe that the Turner Review was quite influential in the wake of the global financial crisis - particularly when one considers that many of its recommendations were adopted in Basel III.

Many of the mathematical scientists who are mentioned by Bernstein (Pascal, Laplace, De Moivre, Galton, Von Neumann) have been omitted in favor of Cardano, Gauss and Mandelbrot - because of their breakthroughs on the applicability of measurement in the domain of the risk, the normal distribution and the departures from the normal distribution, respectively. Injustice is inherent in these types of lists, but there are probably many other great thinkers who have contributed equally (at least) to financial risk management.

My list also reflects the belief that the codification of risk management in a regulatory framework is important. The Basel accords I, II and III are so different from each other that they each “deserve” a separate threshold. Some risk practitioners and academics might disagree with the choice to place these accords on the same influence level as the accomplishments of, say, Mandelbrot or Black and Scholes, but these codifications have had a huge impact on the day-to-day work of risk practitioners.

Why Homer?!

In Homer's Iliad, we read about the final year of the Trojan war, which supposedly took place in the 12th or 11th century B.C. In book 6, the Greek warrior Diomedes meets the Trojan warrior Glaucus on the battlefield and asks about his ancestry.

Glaucus tells Diomedes that his grandfather is Bellerophontes. Diomedes replies that his grandfather, Oeneus, knew Bellerophontes, and notes that they even exchanged friendship gifts. Oeneus gave Bellerophontes a belt, while Bellerophontes gifted Oeneus a gold cup with two handles.

After discovering their ancestral connection, Diomedes and Glaucus decided not to fight each other and agreed to avoid each other on the battlefield. (Diomedes, in fact, tells Glaucus, “There are many more Trojans for me to slay, and Greek soldiers for you.”)

Through an exchange of armor, Diomedes and Glaucus also reprise their grandfathers' gift-giving. Glaucus, however, was at a disadvantage in the exchange, because the god Zeus had taken away his wits. Consequently, Glaucus exchanged his gold armor for Diomedes' bronze. This was a very unequal exchange, because, as the omniscient narrator tells us, Diomedes's bronze armor was only valued at nine oxen, while Glaucus's gold armor was worth 100.

The Glaucus/Diomedes exchange is very much an IFRS 13 valuation avant la lettre. The cattle serve as the “unit of account” (numÉraire). The valuation is calculated by measuring for how many oxen each object could be exchanged. The oxen, moreover, are also a store of value, thereby ticking off two of the three functions of money.

(For the third function of money - the medium of exchange -- the cattle would be impractical. Indeed, several more centuries would need to pass before coin money was used in Greece in the 6th century BC.)

The fair value of the gold armor (100 currency units, or oxen in Homeric times) would have been attained only if the exchange would have happened (per IFRS 13) between knowledgeable and willing market participants. Since this clearly did not apply to the witless Glaucus, the conditions for a fair valuation did not apply and gold was exchanged for bronze - at a price well below its fair value.

Homer's story illustrates that an objective notion of value depends on the exchange between two knowledgeable and willing market participants and is measured in terms of a currency unit that serves as a numÉraire. Necessarily, the value of this numÉraire needs to be stable.

In modern days, a non-volatile, trustworthy currency is needed. In Homer's time, before the invention of fiduciary money, the stability of the numÉraire related to the intrinsic value of cattle.

Parting Thoughts

The currently dominant IFRS 13 fair-value framework share similarities with our first threshold: the definition of value in Homeric times.

Now a staple of IFRS 13, the idea of fair value depending on an exchange between market participants who are knowledgeable and willing was first broached in the story of Diomedes and Glaucus in Homer's Iliad. Homer's definition of value, moreover, eventually led to the creation of VaR - a key risk metric.

If there were a Mt. Rushmore of financial risk management, consideration would have to be given to both legendary thinkers from centuries ago (e.g., Homer and Cardano) and 20th century pioneers like Markowitz and Mandelbrot. Innovative thinking from brilliant minds sparked all of threshold events on our list - everything from probabilistic thinking to portfolio theory to VaR and the Basel accords. These defining moments shaped financial risk management into what it has become today.

Marco Folpmers (FRM) is a professor of financial risk management at Tilburg University and TIAS Business School.


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