Download this Paper Open PDF in Browser

Model Risk of Risk Models

Journal of Financial Stability, Forthcoming

FEDS Working Paper No. 2014-34

33 Pages Posted: 18 Apr 2014 Last revised: 1 Jun 2017

Jon Danielsson

London School of Economics - Systemic Risk Centre

Kevin R. James

London School of Economics & Political Science (LSE) - Systemic Risk Centre; Bank of England

Marcela Valenzuela

University of Chile

Ilknur Zer

Federal Reserve Board

Date Written: November 7, 2015

Abstract

This paper evaluates the model risk of models used for forecasting systemic and market risk. Model risk, which is the potential for different models to provide inconsistent outcomes, is shown to be increasing with market uncertainty. During calm periods, the underlying risk forecast models produce similar risk readings; hence, model risk is typically negligible. However, the disagreement between the various candidate models increases significantly during market distress, further frustrating the reliability of risk readings. Finally, particular conclusions on the underlying reasons for the high model risk and the implications for practitioners and policy makers are discussed.

Keywords: Value-at-Risk, systemic risk, CoVaR, MES, financial stability, Basel III

JEL Classification: G01, G10, G18, G20, G28, G32, G38

Suggested Citation

Danielsson, Jon and James, Kevin R. and Valenzuela, Marcela and Zer, Ilknur, Model Risk of Risk Models (November 7, 2015). Journal of Financial Stability, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2425689 or http://dx.doi.org/10.2139/ssrn.2425689

Jon Danielsson

London School of Economics - Systemic Risk Centre ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44.207.955.6056 (Phone)

HOME PAGE: http://www.riskreasearch.org

Kevin James

London School of Economics & Political Science (LSE) - Systemic Risk Centre ( email )

Houghton St
London
United Kingdom

Bank of England ( email )

25 The North Colonnade
London, E14 5HS
United Kingdom

Marcela Valenzuela (Contact Author)

University of Chile ( email )

Pío Nono Nº1, Providencia
Santiago, R. Metropolitana 7520421
Chile

Ilknur Zer

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Paper statistics

Downloads
969
Rank
18,853
Abstract Views
3,749