Financial Econometrics and Empirical Market Microstructure
The Mechanism of Causal Relationships
Risk interactions play the most important role, because of the existence of close economic, organizational and technological ties between risk owners. The occurrence of some risks (operational, credit, market ones) for some parties implies the emergence of risks for their counterparties. The subsequent chain reaction of credit and market risks propagate through exchange within the economy. In recent decades, these relations have been developing more intensively than ever before, because of market globalization and technological progress.
This causal relationship can be illustrated by a typical example of the domino effect in business environment: discontent of the local population (i. e. political risk, part of operational risks) in Nigeria led to the explosion of a pipeline operated by Royal Dutch Shell on December 21, 2005.[41] As a result, the output was cut by 180,000 barrels per day (operational risk of business interruption); the company declared “force majeure,” which meant its failure to perform contract obligations (credit risks for the counterparties), and the oil price went up by 48 cents per barrel (commodity market risk).
The mechanism of a risk factor’s influence on the emergence of credit and market risks can be illustrated using the well-known Merton approach (Merton 1974), the basis of the Expected Default Frequency (EDF) methodology: distance to default of a firm (i. e. credit risks of its counterparties) is determined by risks associated with the firm’s operations and expressed by the volatility of the market value of the firm’s assets exposed to various types of risk: operational, market, credit ones. The assets volatility determines the volatility of the market capitalization (market risks of investors).
3 Statistical Analysis of Relationships
Correlation and co-integration of market and credit risks are well known and can be explained by changes of risk premium; however, relationships of these risks with various operational risks cannot be adequately explained without identifying a common factor.
Let us define the global risk factor as a global-scale correlator of risk factor volatilities.
Postulate 2. Risks Are Anthropic Human error is the global risk factor.
Human error is not the only risk factor, but it has acquired a global nature.
Causal Relationships of Risk Generation Mechanism
The principal cause of the global influence of the human factor is that it often and strongly affects the sensitivity of assets performance to the majority of other risk factors, no matter what their own nature. In the past decades, the influence of the human factor has been growing due to the operator’s increasing role in business processes and globalization. This is reflected by the increasing correlation of different types of risks.
Investigations of the occurrences of technological operational risk in almost all sectors and regions show that most such events in the last half-century were initially caused by human error rather than technical failure (e. g. Randazzo et al. 2004). And moreover, when caused by technical failure, risk events were mostly the result of accumulated hidden defects due to accumulated maintenance errors caused by organizational errors—again, the human factor. This can be confirmed by many examples, some of which are given below.
The human factor is the main trigger behind the vast majority of transport accidents and disasters. Human errors are responsible for 90 % of all motor vehicle accidents. National statistics of individual countries do not differ much from the world average figures. The human factor accounts for 70-80 % of accidents in air and water transport, and for about 50 % of accidents in railway transport. The human factor is also the dominant cause of industrial accidents and injuries. For instance, about 85 % of lifting crane accidents are associated with violations of labor or technical discipline.
There are about 200 best-known techniques for human factors analysis and assessment, including HAZOP, FTA, ETA, SHERPA, SPEAR, CREAM, THERP, SAPHIRE. For example, the Human Factors Analysis and Classification System (HFACS) (Shappell and Wiegmann 2000) is based on the “Swiss Cheese” model (Reason 2000). The model illustrates errors passing through “holes” (weaknesses) in business processes. According to this theory, there are unsafe acts (errors), preconditions for unsafe acts (including the operator’s psychic factors), unsafe supervision and organizational influences.
Postulate 3. Risks Are Heliogeotropic Human errors and failures (the human factor) depend substantially on preconditions such as the effects of heliogeophysical factors (geomagnetic disturbances, etc.).
Geomagnetic activity depends on solar activity. According to the Svalgaard - Mansurov effect (Mansurov 1969; Svalgaard 1968), the variations of the Earth’s magnetic field are influenced by the sector structure of the interplanetary magnetic field (IMF). These two major factors can disturb the heart rate (Otsuka et al. 2000) and cause human errors, which in turn, according to postulate 1, trigger chain reactions. These result in the occurrence of all types of financial risks (market, credit, operational ones) all over the world, depending on the assets’ sensitivity to the risk factors. (“Geomagnetic Storms” OECD/IFP Futures Project on “Future Global Shocks” CENTRA Technology, Inc., on behalf of Office of Risk Management and Analysis, United States Department of Homeland Security 14.01.2011 IFP/WKP/FGS (2011), Jansen et al. (2000).). Moreover, human intuition and emotions are enhanced during the periods of geomagnetic disturbances, and this enhancement influences market expectations (Krivelyova and Robotti 2003). As related to operational risks caused by risk factors non-correlating with heliogeophysical conditions, their impact depends on the asset sensitivity to these risk factors, while the asset sensitivity itself is heliogeotropic due to the human factor influence.
For a considerable number of risks, the dynamics of risk events can be explained by that of human errors under changing space weather that has a planetary effect. This risk source was termed “the global risk factor” (Rogov 2005, 2006). Astrophysicists have shown the chaotic nature of solar and geomagnetic activity (Spiegel 1993), and this can explain (based on the global risk factor theory) the nature of the observed widely discussed chaotic processes in the markets (Rogov 2003).
