A New Approach to the Quantification of Model Risk for Practitioners

27 Pages Posted: 8 May 2019

See all articles by Zuzana Krajcovicova

Zuzana Krajcovicova

University of Coruña - Department of Mathematics

Pedro Pablo Pérez-Velasco

Banco Santander

Carlos Vázquez Cendón

University of Coruña - Department of Mathematics

Date Written: May 7, 2019

Abstract

Global regulation obliges financial institutions to manage model risk with the same severity as any other risk. Its quantification is therefore essential to meet these requirements and to ensure an institution’s basic internal operations are able to run smoothly. In this paper, we address the quantification of model risk by calculating the norm of an appropriate function defined on a Riemannian manifold endowed with a Fisher–Rao metric. Our aim is twofold: to introduce a mathematical framework that is sufficiently general and sound to cover the main areas of model risk, and to illustrate how a practitioner can identify the relevant abstract concepts and put them to work.

Keywords: model risk, uncertainty, Fisher–Rao information metric, model manifold, exponential map

Suggested Citation

Krajcovicova, Zuzana and Pérez-Velasco, Pedro Pablo and Vázquez Cendón, Carlos, A New Approach to the Quantification of Model Risk for Practitioners (May 7, 2019). Journal of Computational Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3384169

Zuzana Krajcovicova

University of Coruña - Department of Mathematics ( email )

Campus Elvina s/n
A Coruna, 15071
Spain

Pedro Pablo Pérez-Velasco

Banco Santander ( email )

Castellana 24
Madrid, 28046
Spain

Carlos Vázquez Cendón (Contact Author)

University of Coruña - Department of Mathematics ( email )

Campus Elvina s/n
A Coruna, 15071
Spain

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