Incorporating behavioural economics and complexity science would dramatically improve risk management for asset owners and managers

NEW YORK and LONDON, September 21, 2009 — Recent market events have soundly demonstrated that traditional economics does not adequately describe real markets and the potential impacts on financial portfolios, according to a new study released by BNY Mellon (NYSE: BK) and Investor Analytics (IA). By incorporating behavioral characteristics of human market participants and using newly available imaging techniques to understand how humans make real decisions under uncertain circumstances, Behavioral Economics offers an opportunity to gain much more insight into real markets while significantly improving risk management.

The study, entitled "Tomorrow's Risk Management: How behavioral economics, cognitive studies and complexity science add up to more than their own sum," recommends that risk managers explicitly incorporate lessons of known human biases into market stress tests and scenarios. The study reveals several such biases together with specific recommendations on how to use that information for better analysis.

In surveying the fields of Behavioral Economics, Cognitive Studies and Complexity Science, the study highlights that:

• Humans are risk averse when it comes to gains, but risk takers when it comes to losses
• More credibility is given to stories or scenarios that are rich in detail, even though these tend to be statistically less probable to happen
• Rather than diminishing with improved efficiency, volatility is actually a necessary component for markets to exist in the first place and does not change with efficiency.

David Aldrich, head of Alternative Investment Services EMEA at BNY Mellon said, "With the apparent breakdown of traditional risk management and market analysis to provide meaningful assistance in the run up to and during the recent financial crisis, these new fields offer a thought-provoking perspective. We believe firmly that risk management will look very different going forward and will provide enhanced analytics for practitioners to analyse risks within their portfolios."

Dr. Damian Handzy, chairman and CEO of IA added, "This report highlights the critical need for managers, investors and risk professionals alike to take a fresh look at how they are determining risk in their portfolios by incorporating not just the fact that we are 'irrational' decision makers but actually incorporating the very ways in which we are irrational in making our decisions. This is paramount if we are to improve our understanding of markets and their inherent risks."

This whitepaper follows on from BNY Mellon's and Casey Quirk & Associates' recent study entitled, "The Hedge Fund of Tomorrow: Building an Enduring Firm," which addressed key issues facing the alternative investment management industry. BNY Mellon has had an equity stake in Investor Analytics for five years and recently increased its investment.

In June, BNY Mellon announced that it had formed a strategic alliance with Investor Analytics to provide enterprise-wide risk analysis and reporting for asset owners and managers. The alliance makes IA's sophisticated risk analyses available to BNY Mellon clients worldwide, including banks, pension funds, asset managers, hedge funds, and other investment professionals. Through the alliance, BNY Mellon clients have access to tools to measure and manage investment risks across multiple asset classes, strategies and portfolios using state of the art risk analytics, calculations, portfolio stress testing, and historical scenario analysis.

Investor Analytics LLC, headquartered in Berkeley Heights, New Jersey with offices in Midtown Manhattan and Central Ohio, has been providing portfolio and risk management services to the investment management industry since 1999. Investor Analytics employs proprietary methodologies to analyze complex investment portfolios and provides clients with a suite of risk and transparency analyses. More information is available at www.investoranalytics.com

BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation. BNY Mellon is a global financial services company focused on helping clients manage and service their financial assets, operating in 34 countries and serving more than 100 markets. The company is a leading provider of financial services for institutions, corporations and high-net-worth individuals, providing superior asset management and wealth management, asset servicing, issuer services, clearing services and treasury services through a worldwide client-focused team. It has $20.7 trillion in assets under custody and administration, $926 billion in assets under management, services more than $11.8 trillion in outstanding debt, and processes global payments averaging $1.8 trillion per day. Additional information is available at bnymellon.com.