What Is an Event Risk
Broadly, event risk is the possibility that an unforeseen event will negatively affect a company, industry, or security causing a loss to investors or other stakeholders. While these events are typically unforeseen, the probability of certain events like corporate actions, credit events, or other hazards can still be hedged or insured against.
- Event risk refers to any unforeseen or unexpected occurrence that can cause losses for investors or other stakeholders in a company or investment.
- Credit events such as default or bankruptcy can be hedged against using credit default swaps or other credit derivatives.
- External events such as natural disaster or theft can be minimized through insurance policies that cover such hazards.
Understanding Event Risk
Event risk can refer to several different types of occurrences, but generally can be classified as one of the following:
- Unforeseen corporate reorganizations or bond buybacks may have positive or negative impacts on the market price of a stock. The possibility of a corporate takeover or restructuring, such as a merger, acquisition, or leveraged buyout all come into play. These events can require a firm to take on new or additional debt, possibly at higher interest rates, which it may have trouble repaying. Companies also face event risk from the possibility that the CEO could die suddenly, an essential product could be recalled, the company could come under investigation for suspected wrongdoing, the price of a key input could suddenly increase substantially or countless other sources. Firms also face regulatory risk, in that a new law could require a company to make substantial and costly changes in its business model. For example, if the president signed a law making the sale of cigarettes illegal, a company whose business was the sale of cigarettes would suddenly find itself out of business.
- Event risk can also be associated with a changing portfolio value due to large swings in market prices. It is also referred to as "gap risk" or "jump risk." These are extreme portfolio risks due to substantial changes in overall market prices that occur due to news events or headlines that occur when normal market hours are closed. This sort of activity was seen frequently, for example, during the global financial crisis of 2008-09.
- Event risk can also be defined as the possibility that a bond issuer will miss a coupon payment to bondholders because of a dramatic and unexpected event. Credit rating agencies may downgrade the issuer’s credit rating as a result, and the company will have to pay investors more for the higher risk of holding its debt. These events pose credit risk.
Minimizing Event Risk
Companies can easily insure against some types of event risk, such as fire, but other events, such as terrorist attacks, may be impossible to ensure against because insurers don’t offer policies that cover such unforeseeable and potentially devastating events. In some cases, companies can protect themselves against risks through financial products such as an act of God bonds, swaps, options, and collateralized debt obligations (CDOs).
Investors at risk of credit events can use credit derivatives such as credit default swaps (CDS) or options contracts to hedge against default of a company. In addition, investors can utilize stop and stop-limit orders to minimize potential losses created by a security gapping between trading hours.