Novel Risks: A Research and Policy Overview

Abstract

In a broad sense, novel risks arise from environmental-, governance-, healthcare-, social responsibility–, sustainability-, and technology-related shortcomings of or challenges faced by firms, as well as the uncertainty caused by potential domestic and global regulatory policy responses. Recent academic literature suggests that there are parallels among environmental, social, and governance (ESG) risk, climate change risk, cybersecurity risk, and geopolitical risk in terms of measurement challenges, including but not limited to emerging data and measurement methods; the similarities in terms of their insufficient, noncomparable, less-specific, and non–decision-useful disclosures; and the potential interaction between these risks. Establishment of consistent disclosure policy and reporting requirements as well as improvement in measuring the impact of these novel risks on asset prices, volatility, and global financial stability is at the forefront of contemporary financial economics and portfolio management.

TOPICS: Risk management, tail risks, ESG investing, legal/regulatory/public policy

Key Findings

• ▪ A broad characterization of novel risks is presented, and environmental, social, and governance (ESG) risk, climate change risk, cybersecurity risk, and geopolitical risk specifically are defined.

• ▪ An overview of the recent academic literature suggests that there are parallels among these novel risks in terms of measurement challenges and disclosure regulations.

• ▪ Measures based on novel applications of text and news analytics are identified as proxies for novel risks as investigated in the recent academic literature.