Risk management in the global economy: A review essay William C. Hunter a , Stephen D. Smith b,c, * a Federal Reserve Bank of Chicago, Chicago, IL, USA b Department of Finance, Georgia State University, 35 Broad Street, Atlanta, GA 30303, USA c Federal Reserve Bank of Atlanta, Atlanta, GA, USA Abstract Thispaperprovidesareviewofdevelopmentsintheareaofriskmanagementatboth thefirmlevelandthemacro-economy.Wereviewrationalesregardingwhyfirmschoose to manage risk, as well as new developments in measuring and managing risk in a dynamic setting. We also consider current risk sharing arrangements in light of the theory regarding optimal risk sharing. The paper concludes with some suggestions for additional research that emphasizes the importance of incorporating market incom- pleteness in an equilibrium setting. We also discuss the role of incompleteness at the macro-level and speculate on how derivatives markets may influence macro-economic stabilization policy. Ó 2002 Published by Elsevier Science B.V. JEL classification: D84; G28; G38 Keywords: Risk management; Portfolio theory; Incomplete markets 1. Introduction The first paper regarding the relevance of financial risk management was arguably written over forty years ago by Modigliani and Miller (1958). In that paper they show that in frictionless markets with no taxes, the value of the Journal of Banking & Finance 26 (2002) 205–221 www.elsevier.com/locate/econbase * Corresponding author. Tel.: +1-404-651-1236; fax: +1-404-651-2630. E-mail address: sdsmith@gsu.edu (S.D. Smith). 0378-4266/02/$ - see front matter Ó 2002 Published by Elsevier Science B.V. PII:S0378-4266(01)00219-9