The recent financial crisis was unkind to treasurers of many multinationals, in part because exposures they presumed to be uncorrelated–hence diversified and less risky–suddenly became highly correlated. Most foreign exchange rates, for example, were assumed to be largely uncorrelated, but in the crisis the U.S. dollar rallied almost uniformly against all world currencies.
"Correlations move closer to one when the world is about to end. Without taking this into account, many risk managers are relying on a diversification benefit exactly when it isn't going to be there," says Adrian Crockett, head of Credit Suisse Securities' strategic finance group.
Such unlikely "tail events" can wreak havoc on conventional risk management practices. Credit Suisse client Cisco Systems' cash flows actually benefited from the dollar's rally, because its non-dollar expenses exceeded its non-dollar revenue, causing a reduction in funding costs. Since extreme dollar moves could occur in the opposite direction, Cisco's treasury department decided to scrutinize its FX risk management practices.
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