You're walking through wolf-infested woods with a large package of raw meat in your backpack. You start to get a little nervous, so you move the meat to someone else's pack. Transfer of risk.
The financial version of the term works much the same way. The goal is to move the consequence of an unfavorable event onto someone else. Something goes wrong, but you don't have to pay for it. Someone else does. That situation defines a transfer of risk.
The most obvious example involves insurance. When you get an insurance policy, you're effectively conducting a transfer of risk. Now, if your car gets wrecked in an accident, or your house gets wrecked by a coordinated beaver attack, you don't have to pay to get it repaired. The insurance company does.
Insurance companies pull this maneuver as well. They don't just sit on all the risk they have. They look to transfer it. So insurance firms enter into reinsurance contracts with other companies, transferring a portion of their risk onto another firm.
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Finance: What is Event Risk?6 Views
Finance a la shmoop what is event risk risk risk risque er yeah,
how'd that get in here all right moving on investing carries all kinds of risk
inflation risk is a biggie for those who like to buy safe government low-interest [100 dollar bill inflates]
low risk paper yes their investments always pay back but while they only get
like 2% kind of returns and in a world of 3% inflation well that's a big
problem well then there's market risk too [S&P 500 graph appears]
stock markets go up and down all the time so yes over time they go up but
well you might own stock in a great company that in a bad market gets taken
down like all the other boats in the ocean when a big quake hits and suddenly
it's a tsunami time and well everything drops but historically if you hold good [People in discussion at a meeting]
companies long enough well well their high quality bails you out of any
short-term losses you've suffered so if these are normal risks that happen all
the time they're things that just go on and on it's all part of the investing
world then what's an event risk which implies that something happened there
was a vent there was a finite period of time a finite situation that made bad
things happen with the overhang that events you know like a solar eclipse or [Solar eclipse appears]
or the election of a smart ethical congressman well those don't happen all
the time that's an event right it's a one-time thing well here's an event a
meteor hits the earth and all of a sudden while the most prized possessions [Meteor strikes earth]
are simple things like water and gas and land with wood and animals yeah that's
an event well the value of your Amazon and Netflix stock in that case well
those companies are probably not worth whole lot cuz internet is probably
dead or at least injured so when wizened old investors invest they typically [Old investors appear holding stock]
think about "once in a lifetime" events with event risk as being
a risk that they have to account for and yes thinking about that meteor hitting
the earth in fact is one of the things that professional portfolio manager
thinks about when building their fund and if you want to do something a little
more realistic than a meteor what about some crazy dictator and [Rocket appears in the sky]
Korea nuking us yeah not like one in a gazillion chance probably well more
recent event was the near-death experience of the US financial system in
the 2008/09 mortgage crisis where trust in banks and the banking system
almost led to the bankruptcy of Goldman Sachs Bank of America JP Morgan and a
bunch of other formerly perceived as bulletproof financial institutions yes
there was an event and a whole lot of risk and we almost died
financially anyway eventually the capital markets worked investors came to
trust the system again and they invested their money in the stock market with [Cash piles up]
staggering results in that the stock market went up some 400 percent in the
decade after the financial crisis so events are a real thing you have to
think about them until you don't [Man falling to the ground on a rocket]
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