Model risk, model misspecification, model misapplication, implementation risk, model calibration, programming errors, data problems, model uncertainty, model risk management, model creep, model vetting, risk oversight
Financial models by definition are simplified representations of the complex realities of financial markets, and so at a minimum the use of any model introduces risk that its representation of reality is flawed or too incomplete. This chapter considers the use of models and the associated model risks. The reading begins by examining the general process by which models are developed and then highlights where errors can occur, from model misspecification to model misapplication to improper calibration and programming errors. Since the ability to quantify model risk is challenging and limited, the author ends the chapter with practical guidelines for managing model risk for developers, managers and institutions.
16.1 Models and model risk
16.2 Sources of model risk
16.2.1 Incorrect model specification
16.2.2 Incorrect model application
16.2.3 Implementation risk
16.2.4 Other sources of model risk
16.3 Quantifying model risk
16.4 Managing model risk
16.4.1 Managing model risk: some guidelines for risk practitioners
16.4.2 Managing model risk: some guidelines for senior managers
16.4.3 Institutional methods to manage model risk
16.5 Model risk
*** From the publisher ***
Fully revised and restructured, Measuring Market Risk, Second Edition includes a new chapter on options risk management, as well as substantial new information on parametric risk, non-parametric measurements and liquidity risks, more practical information to help with specific calculations, and new examples including Q&A’s and case studies. The accompanying CD-ROM includes a Measuring Market Risk toolbox, with about 150 risk measurement functions, a manual and a selection of Excel workbooks illustrating basic risk measurement functions.