About the Impact of Model Risk on Capital Reserves: A Quantitative Analysis
AbstractThis paper analyzes and quantifies the idea of model risk in the environment of internal model building. We define various types of model risk including estimation risk, model risk in distribution and model risk in functional form. By the quantification of these concepts we analyze the impact of the modeling process of an econometric model on the resulting company model. Utilizing real insurance data we specify, estimate and simulate various linear and nonlinear time series models for the inflation rate and examine its impact on pension liabilities under the aspect of model risk. Under consideration of different risk measures it is shown that model risk can differ profoundly due to the specification process of the econometric model resulting in remarkable monetary differences concerning capital reserves. We furthermore propose a specification strategy for univariate time series models and demonstrate that thereby market risk and capital reserves can be reduced distinctively.
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Bibliographic InfoPaper provided by Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät in its series Hannover Economic Papers (HEP) with number dp-469.
Length: 28 pages
Date of creation: Mar 2011
Date of revision:
Model risk; Estimation risk; Misspecification risk; Basel multiplication factor; Empirical model specification; Capital reserves;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-02 (All new papers)
- NEP-CBA-2011-04-02 (Central Banking)
- NEP-CMP-2011-04-02 (Computational Economics)
- NEP-RMG-2011-04-02 (Risk Management)
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