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What Is Economic Risk Analysis?

C. Mitchell
C. Mitchell

Economic risk analysis is a method or technique used to conceptualize the large-scale financial ramifications of certain actions. Most of the time, economic risk analysis is performed before an action is taken. This way, analysts are able to anticipate potential pitfalls, draft mitigation strategies, and choose the steps most likely to yield positive results. Analysis can also be performed after events — particularly accidents or disasters — to understand the forces at play and to learn ways of avoiding such calamity in the future.

When analysts talk about economic risk, they are mostly looking at monetary consequences across a broad spectrum. Financial analysis — that is, understanding the relationship between profits and losses — is part of the calculation. In most cases economic risks are experienced through a slow trickle, however, which requires a broader lens than simply immediate finances. A loss in one sector may cause other sectors to make different choices, alter investments, or modify core structures. Analysis techniques look for ways of conceptualizing and predicting risk factors to provide a complete picture of all possible effects.

Some of the most basic economic risk analysis happens in the financial sector.
Some of the most basic economic risk analysis happens in the financial sector.

Some of the most basic economic risk analysis happens in the financial sector. Individuals and businesses with money to invest often want to understand the potential downsides of certain investment vehicles or holdings. In these contexts, analysis will outline the loss potential as weighted against the strength of international markets and known economic indicators. This kind of analysis encapsulates not only the chance of loss but also the potential causes and sources of that loss. It is usually presented to investors in a portfolio report that provides a number of options with the risk quotient of each delineated.

Governments also perform economic risk analysis for projects that would significantly impact certain sectors, such as expanding highways or approving new trade partners. One of the main goals is to better substantiate the opportunity costs of a given project or proposal. Analysts start out by looking at immediate impacts, then expand their study to consider economic indicators spread out across time. The analysis here is often seen to be a bit speculative, but it is grounded on statistical calculations and documented local indicators.

Officials use economic analysis reports to ensure that proposed actions will not come up negative on a cost benefit analysis. Reports also help decision makers become aware of outcomes that might not be visible immediately. A new highway might bring great benefits globally, but could cause major traffic congestion problems in local communities, for instance, which could impact spending on repairs, pollution reduction, and a host of other things. Similarly, changes to import patterns in one sector may have far-reaching effects to small businesses providing completely different goods elsewhere. Awareness of these risks upfront can help planning officials mitigate them at the outset.

Sometimes, corporations and governments also engage in economic risk analysis after major failures. This sort of analysis is designed not to help mitigate potential risk, but rather to learn form risks that have been realized. Analysts in these situations often dissect major accidents, significant corporate losses, and natural disaster responses to gain insight on how to improve moving forward.

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    • Some of the most basic economic risk analysis happens in the financial sector.
      By: Rawpixel
      Some of the most basic economic risk analysis happens in the financial sector.