A Practical Approach to Quantitative Model Risk Assessment

49 Pages Posted: 27 Apr 2020 Last revised: 1 Mar 2023

See all articles by Carole Bernard

Carole Bernard

Grenoble Ecole de Management; Vrije Universiteit Brussel (VUB)

Rodrigue Kazzi

Vrije Universiteit Brussel (VUB); KU Leuven

Steven Vanduffel

Vrije Universiteit Brussel (VUB)

Date Written: March 31, 2020

Abstract

Model-based decisions are highly sensitive to model risk that arises from the inadequacy of the adopted model. This paper reviews the existing literature on model risk assessment and shows how to use the theoretical results to develop a corresponding best practice. Specifically, we develop tools to assess the contribution to model risk of each of the assumptions that underpin the adopted model. Furthermore, we introduce new model risk measures and propose an intuitive formula for computing model risk capital. Some numerical examples and a case study illustrate our results.

Keywords: Value-at-Risk, Risk bounds, Model risk contribution, Model risk capital requirements, Parameter risk, Credibility factors, Generalized Pareto distribution

Suggested Citation

Bernard, Carole and Kazzi, Rodrigue and Vanduffel, Steven, A Practical Approach to Quantitative Model Risk Assessment (March 31, 2020). Available at SSRN: https://ssrn.com/abstract=3565116 or http://dx.doi.org/10.2139/ssrn.3565116

Carole Bernard

Grenoble Ecole de Management ( email )

12, rue Pierre Sémard
Grenoble Cedex, 38003
France

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
http://www.vub.ac.be/
Brussels, 1050
Belgium

Rodrigue Kazzi (Contact Author)

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
http://www.vub.ac.be/
Brussels, 1050
Belgium

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Steven Vanduffel

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
Brussels, Brabant 1050
Belgium

HOME PAGE: http://www.stevenvanduffel.com

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