Related and Correlated Risks

Related risks are risks that vary because of the presence of another risk. This means they do not exist independently and they are likely to rise and fall in importance along with the related one. Risk correlation is a particular example of related risk.

Risks are positively correlated if the two risks are positively related in that one will fall with the reduction of the other and increase with the rise of the other. They would be negatively correlated if one rose as the other fell.

In the case of environmental risks and reputation risk, they may be positively correlated for the following reasons:


***Environmental risks involve exposure to losses arising from an organisation’s consumption of resources or impacts through its emissions. Where an environmental risk affects a sensitive situation, (be it human, flora, fauna or other), this can cause negative publicity which can result in reputation damage.

***These two risks can have a shared cause, i.e. they can arise together and fall together because they depend upon the same activity. They are considered separate risks because losses can be incurred by either of both of the impacts (environmental or reputational).

***Positively correlated risk - Activities designed to reduce environmental risk, such as acquiring resources from less environmentally-sensitive sources or through the fitting of emission controls, will reduce the likelihood of the environmental risk being realised. This, in turn, will reduce the likelihood of the reputation risk being incurred. The opposite will also hold true: a reduction of attention to environmental risk will increase the likelihood of reputation loss.


***Negatively correlated risks are also present in some situations. If, for example, a company borrows money to reduce its environmental emissions then it might be that its environmental risks are reduced but, with its increased gearing, its financial risks are increased at the same time. This is because the higher gearing will increase the vulnerability to rising interest rates and put pressure on cash flow. In this case, then, there is a direct relationship between the environmental risk reducing and the financial risk increasing.



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