The Pernicious Effects of Contaminated Data in Risk Management

43 Pages Posted: 15 Jan 2010 Last revised: 14 Mar 2013

See all articles by Laurent Frésard

Laurent Frésard

University of Lugano; Swiss Finance Institute

Christophe Perignon

HEC Paris - Finance Department

Anders Vilhelmsson

Lund University - Department of Economics

Date Written: February 11, 2011


Banks hold capital to guard against unexpected surges in losses and long freezes in financial markets. The minimum level of capital is set by banking regulators as a function of the banks’ own estimates of their risk exposures. As a result, a great challenge for both banks and regulators is to validate internal risk models. We show that a large fraction of US and international banks uses contaminated data when testing their models. In particular, most banks validate their market risk model using profit-and-loss (P/L) data that include fees and commissions and intraday trading revenues. This practice is inconsistent with the definition of the employed market risk measure. Using both bank data and simulations, we find that data contamination has dramatic implications for model validation and can lead to the acceptance of misspecified risk models. Moreover, our estimates suggest that the use of contaminated data can significantly reduce (market-risk induced) regulatory capital.

Keywords: Regulatory capital, proprietary trading, backtesting, value-at-risk, profit-and-loss

JEL Classification: G21, G28, G32

Suggested Citation

Frésard, Laurent and Perignon, Christophe and Vilhelmsson, Anders, The Pernicious Effects of Contaminated Data in Risk Management (February 11, 2011). Available at SSRN: or

Laurent Frésard

University of Lugano ( email )

Lugano, 900

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4

Christophe Perignon (Contact Author)

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351

Anders Vilhelmsson

Lund University - Department of Economics ( email )


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