A Gentle Introduction to Model Risk Quantification in Commercial Banking

Abstract

Model risk is investigated from a commercial banking viewpoint. We firstly analyze model misspecification. Then, the focus shifts towards model sensitivity. Finally, interactions among various models are scrutinized. Our overarching goal is to derive a distribution of indicators for summarizing the impact of model risk on synthetic measures like bank’s economic, capital, liquidity ratios, and so on. Governance impacts are also considered in terms of the definition of a comprehensive model appetite framework with corresponding tolerance bands.

Keywords

• model risk
• uncertainty
• extreme event