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Market and model risks: a feasible joint estimate methodology

Author

Listed:
  • Mariano González-Sánchez

    (UNED (Universidad Nacional de Educación a Distancia))

  • Eva M. Ibáñez Jiménez

    (UNED (Universidad Nacional de Educación a Distancia))

  • Ana I. Segovia San Juan

    (UNED (Universidad Nacional de Educación a Distancia))

Abstract

The increasing complexity of stochastic models used to describe the behavior of asset returns along with the practical difficulty of defining suitable hedging strategies are relevant factors that compromise the soundness and quality of risk measurement models. In this paper we define the risk model as the mispricing a consequence of using an inadequate model to describe asset behavior and we develop a least-squares Monte Carlo methodology to estimate market and model risk simultaneously. The results show that at different confidence levels and time horizons the proposed methodology to estimate the market and model risks has a greater joint explanatory power than the isolated estimate of market risk.

Suggested Citation

  • Mariano González-Sánchez & Eva M. Ibáñez Jiménez & Ana I. Segovia San Juan, 2022. "Market and model risks: a feasible joint estimate methodology," Risk Management, Palgrave Macmillan, vol. 24(3), pages 187-213, September.
    • Handle: RePEc:pal:risman:v:24:y:2022:i:3:d:10.1057_s41283-022-00090-1
    DOI: 10.1057/s41283-022-00090-1
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    More about this item

    Keywords

    Model risk; Simulation model; Stochastic process; Monte Carlo; Least-squares;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C35 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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