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Thought Leadership in ERM | Risk Assessment in Practice | 13

Where historical data are available, risk interactions can for identification and assessment of risk responses and key
be expressed quantitatively using a correlation matrix. risk indicators. The diagrams can be qualitative or serve
This is an especially useful technique to apply within a risk as the basis for quantitative models. Three commonly used
category such as market risk. Difficulties in determining diagrams are fault trees, event trees, and bow-ties. Fault
correlations for risks include the possibility that past causal trees are used for analyzing events or combinations of
relationships will not be indicative of future relationships, events that might lead to a hazard or an event. Event trees
lack of historical data, differences in time frames (short-, are used for modeling sequences of events arising from
medium-, and long-term), and the large numbers of risks a single risk occurrence. A bow-tie diagram combines a
required for an enterprise-wide assessment. fault tree and an event tree and takes its name from its
shape. Probabilistic models built on bow-tie diagrams are
Developing the Full Picture—Fault Trees, versatile for quantifying inherent and residual risk levels
Event Trees, and Bow-Tie Diagrams and performing what-if, scenario, and sensitivity analyses.
Diagrams that break a complex risk occurrence into its
component parts showing the chains of events that could
lead to or result from the occurrence can be indispensable

Exhibit 4: Bow-Tie Diagram

Risk Factors Risk Consequences

Trigger Intermediate End Consequence End Event
Event Event Event (Loss)

Trigger Intermediate End Consequence End Event
Event Event Event (Loss)

Intermediate End Consequence End Event
Event Event (Loss)

Intermediate End Risk Consequence End Event
Event Event (Loss)

Intermediate End End Event
Condition Consequence
Event Event (Loss)

Intermediate End End Event
Condition Consequence
Event Event (Loss)

Condition Intermediate End Consequence End Event
Event Event (Loss)

Note: The terms fault tree, event tree, and bow-tie diagram are sometimes used interchangeably.

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