Risk Model Validation

Worldwide, senior executives and managers in financial and non-financial firms are expected to make crucial business decisions based on the results of complex risk models. Yet interpreting the findings, understanding the limitations of the models and recognizing the assumptions that underpin them present considerable challenges for all but those with a background in specialized quantitative financial modeling.

The use of these quantitative risk models was blamed as being one of the major causes of the financial crisis that began in 2007. This report shows how risk models are constructed and why they play such an important role in financial markets. It provides a holistic approach to Risk Model Validation that will enable you, when faced with a specific risk model, to work out a step-by-step guide to asking the right questions in order to judge the validity of the model.

Mathematical modelling, implementation, data gathering, processes, reporting and the way senior management “digests” all this information will all be covered.

An essential part of a decision-maker’s armoury, Risk Model Validation provides an intensive guide to asking the key questions when integrating the outputs of quantitative modeling into everyday business decisions.

Senior management are expected to make crucial business decisions using complex risk models that, without specialized quantitative financial knowledge, can lead to ill judged choices. The recent controversial discussions concerning the use of risk models during the financial crisis, and the new regulatory framework, have highlighted the need for a consistent approach to answer the question “What are risk models made for?” and maybe even more importantly “What are risk models NOT made for?”.

The report aims to explain:

• What risk model validation is;
• What risk models exist;
• How a risk model can fail;
• Which aspects of reality are included, and which aspects are excluded from a risk model; and
• How business decisions can be based on a risk models’ output.

In addressing these issues, this report provides practical advice to the management of financial institutions and a toolbox to raise the key questions when it comes to integrating the results of quantitative models into business decisions.