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Model Risk and Regulatory Capital (2002)
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BibTeX
@MISC{Kerkhof02modelrisk,
author = {Jeroen Kerkhof and Bertrand Melenberg and Hans Schumacher},
title = { Model Risk and Regulatory Capital},
year = {2002}
}
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Abstract
In this paper we propose a general framework for quantification of model risk. This framework allows one to allocate regulatory capital to positions in a given market depending on the extent to which this market can be reliably modeled. Our approach is based on computing worst-case risk measures over sets of models that are in some appropriate sense close to a nominal model. The method is general in the sense that it can be applied with any of the usual risk measures such as Value-at-Risk and Tail Conditional Expectation. Inasfar as risk measures can also be used as pricing tools or as determinants of margin requirements, the paper provides a quantification of model risk in these settings as well. We present applications both to stock portfolios and to derivative products: we find that, for usual specifications, misspecification risk is much more important than estimation risk.
Keyphrases
model risk regulatory capital present application usual risk measure estimation risk general framework stock portfolio misspecification risk worst-case risk measure usual specification tail conditional expectation derivative product risk measure nominal model pricing tool appropriate sense margin requirement
