Model risk and techniques for controlling market parameters. The experience in Banco Popolare
AbstractThe increasing use of internal market models for market risk assessment and management promotes, in compliance with Basel II, better risk management practices but introduces at the same time the so called model risk. In the light of the many open issues connected to market risk, the aim of this paper is twofold. First, it offers a formal analysis of model risk which is aimed to clarify quantification issues and to illustrate the architecture of a control process for this type of risk. An important building block of such an architecture is the so called market parameters control process, which is the focus of the present paper and consists of two different phases: the definition of the data sources and the data retrieval forms, and the definition of the techniques for valuing variables (i.e. input model data) based on market data. Second, this paper proposes a market parameters control process and its implementation within an important Italian bank, namely Gruppo Banco Popolare. Specifically, by focusing on equity market risk, this paper illustrates the whole organization process needed to set up and implement the market parameters control techniques, which imply first controlling for integrity (existence, domain, homogeneity) and outliers and then performing benchmarking activities. Special emphasis is placed on the so-called second level parameters, which do not have official quotes and still are fundamental especially in valuing non linear positions (e.g. volatility). These activities are based on mathematical-statistical models, whose implementation has required the development of specific software and IT solutions and the adoption of an articulate organizational structure.
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Bibliographic InfoPaper provided by Universita di Modena e Reggio Emilia, Facoltà di Economia "Marco Biagi" in its series Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) with number 07102.
Length: pages 50
Date of creation: Oct 2007
Date of revision:
model risk; market parameters; control process;
Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-10-27 (All new papers)
- NEP-BAN-2007-10-27 (Banking)
- NEP-RMG-2007-10-27 (Risk Management)
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