A practical guide to market risk model validations

What are the most common modeling issues in market risk management, and which validation techniques are the most popular?
  • 14 Junio 2017

Por Vilen Abramov, Matt Lowdermilk y Xianwen Zhou

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Abstract

The financial crisis of 2008 has been extremely challenging and, at the same time, illuminating period for market risk managers. The crisis revealed a convoluted nature of the market risk and put market risk models to the crash test. The epic failure of the risk management models culminated in a historic US credit rating downgrade on political risks and rising debt burden. In this paper series, we review common modeling issues and validation techniques used in the market risk management area. We focus on the pricing, hedging and value at risk (VaR) models. Counterparty credit risk models have been excluded as they deserve a separate treatment. We discuss model risk events, market risk functional areas, common modeling issues, and model validation techniques. We have developed practical model validation procedures that should help validators to provide ”effective challenge.” The paper also contains a number of real examples.

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