Economic Foundation of Risk Management, Agency, and Financial Intermediation

This paper reviews the literature on the economic foundation of risk management and financial and insurance intermediation. First, the traditional theories on investment, hedging, and insurance and their relations with other production activities as a result of risk aversion are summarized. Second, the economics of self-protection and risk reduction activities is reviewed. Third, recent development in the agency problems related to financial and insurance intermediation, the presence of risk-averse managers, and outsourcing on company's risk taking and risk management activities is discussed. Fourth, financial and insurance intermediation which is an essential part of risk management is reviewed with a focus on the effects of fraud and verification. Finally, the agency risk faced by companies due to the existence of financial intermediaries and buying agents is discussed in the context of search theory.