Measuring Model Risk
Model risk as part of the operational risk is a serious problem for financial institutions. As the pricing of derivatives as well as the computation of the market or credit risk of an institution depend on statistical models the application of a wrong model can lead to a serious over- or underestimation of the institution’s risk. Because the underlying data generating process is unknown in practice evaluating the model risk is a challenge. So far, definitions of model risk are either application-oriented including risk induced by the statistician rather than by the statistical model or research-oriented and too abstract to be used in practice. Especially, they are not data-driven. We introduce a data driven notion of model risk which includes the features of the research-oriented approach by extending it by a statistical model building procedure and therefore compromises between the two definitions at hand. We furthermore suggest the application of robust estimates to reduce the model risk and advocate the application of stress tests with respect to the valuation of the portfolio.
|Date of creation:||Nov 2008|
|Contact details of provider:|| Postal: Koenigsworther Platz 1, D-30167 Hannover|
Phone: (0511) 762-5350
Fax: (0511) 762-5665
Web page: http://www.wiwi.uni-hannover.de
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Stefan Jaschke & Gerhard Stahl & Richard Stehle, 2007. "Value-at-risk forecasts under scrutiny—the German experience," Quantitative Finance, Taylor & Francis Journals, vol. 7(6), pages 621-636.
- Kerkhof, F.L.J. & Melenberg, B. & Schumacher, J.M., 2002. "Model Risk and Regulatory Capital," Discussion Paper 2002-27, Tilburg University, Center for Economic Research.
- Philipp Sibbertsen, 1999. "S-Estimation in the Linear Regression Model with Long-Memory Error Terms," Computing in Economics and Finance 1999 512, Society for Computational Economics.
- Bakshi, Gurdip & Cao, Charles & Chen, Zhiwu, 1997.
" Empirical Performance of Alternative Option Pricing Models,"
Journal of Finance,
American Finance Association, vol. 52(5), pages 2003-2049, December.
- Charles Quanwei Cao & Gurdip S. Bakshi & Zhiwu Chen, 1997. "Empirical Performance of Alternative Option Pricing Models," Yale School of Management Working Papers ysm54, Yale School of Management.
- Charles Quanwei Cao & Gurdip S. Bakshi & Zhiwu Chen, 1997. "Empirical Performance of Alternative Option Pricing Models," Yale School of Management Working Papers ysm65, Yale School of Management.
- T. Clifton Green & Stephen Figlewski, 1999. "Market Risk and Model Risk for a Financial Institution Writing Options," Journal of Finance, American Finance Association, vol. 54(4), pages 1465-1499, 08.
- Rama Cont & Romain Deguest & Giacomo Scandolo, 2010. "Robustness and sensitivity analysis of risk measurement procedures," Quantitative Finance, Taylor & Francis Journals, vol. 10(6), pages 593-606.
- Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
- Carol Alexander, 2005. "The Present and Future of Financial Risk Management," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 3(1), pages 3-25.
- Corradi, Valentina & Swanson, Norman R., 2006. "Predictive Density Evaluation," Handbook of Economic Forecasting, Elsevier.
When requesting a correction, please mention this item's handle: RePEc:han:dpaper:dp-409. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Heidrich, Christian)
If references are entirely missing, you can add them using this form.