Uncertainty boosts extreme risks – survey

Economic depression remains the leading global economic risk followed by the risk of sovereign default according to Towers Watson’s ranking of the top fifteen extreme risk. The threat of hyperinflation follows in third place.

The rankings list events that would have a high impact on global economic growth and asset returns if they occurred. The change of ranking reflects a change of view regarding both impact and likelihood of each individual risk.
This is the second edition of the rankings entitled “Extreme Risks – the 2011 update” since the original 2009 survey. It reflects the sluggish economic recovery in the developed world during the past two years which the authors say increases the likelihood of further economic shocks.

The threat of sovereign default has increased from “medium” to “high”. Recent economic and political developments in the eurozone suggest that a break-up of the euro was more likely with this risk rising from “very low” to “low”.

Tim Hodgson, head of the company’s “thinking ahead group”, said the global environment continued to display significant imbalances and would not be in good shape to withstand more major shocks.

The rankings lists a number of events that could disrupt the recovery and long-term economic developments. They aim to help asset owners consider and better manage their investment risk, though the potential impact of many risks remains unknown and other as yet unknown risks may have a more damaging impact.

“Even with the best analysis, we will not be able to anticipate all risks. The important thing is to build our ability to adapt and learn, enhancing the resilience of the system,” said Hodgson.

The research has added two new extreme risks: resource scarcity and infrastructure failure to replace the end of capitalism and excessive leverage.

Resource scarcity covers energy, metals, water or arable land. It assesses the likely mismatch between resources and rising demand from a growing population.

“Technology optimists argue that the contribution of technological advancement can help meet the increasing demand, but certain resources – such as water or arable land – have no easy substitutes,” said Hodgson.

Infrastructure failure includes the risks posed by the dependence of modern economies on computer networks and power grids. The cost of such a failure would rise exponentially the longer the networks remained unoperational, the research said.

Not all extreme risks can be hedged and any hedge used is likely to be imprecise, the research said. It cites the example of the outcome of a killer pandemic being highly uncertain and therefore its impact on assets and liabilities cannot be estimated.

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