In finance, model risk is the risk of loss resulting from using models to make decisions, initially and frequently referring to valuing financial securities. However model risk is more and more prevalent in industries other than financial securities valuation, such as consumer credit score, real-time probability prediction of a fradulent credit card transaction to the probability of air flight passenger being a terrorist. Rebonato in 2002 considers alternative definitions including:
- After observing a set of prices for the underlying and hedging instruments, different but identically calibrated models might produce different prices for the same exotic product.
- Losses will be incurred because of an ‘incorrect’ hedging strategy suggested by a model.
Rebonato defines model risk as "the risk of occurrence of a significant difference between the mark-to-model value of a complex and/or illiquid instrument, and the price at which the same instrument is revealed to have traded in the market."
Read more about Model Risk: Types of Model Risk, Case Studies, See Also
Famous quotes containing the words model and/or risk:
“...that absolutely everything beloved and cherished of the bourgeoisie, the conservative, the cowardly, and the impotent—the State, family life, secular art and science—was consciously or unconsciously hostile to the religious idea, to the Church, whose innate tendency and permanent aim was the dissolution of all existing worldly orders, and the reconstitution of society after the model of the ideal, the communistic City of God.”
—Thomas Mann (1875–1955)
“The appetite for power, even for universal power, is only insane when there is no possibility of indulging it; a man who sees the possibility opening before him and does not try to grasp it, even at the risk of destroying himself and his country, is either a saint or a mediocrity.”
—Simone Weil (1909–1943)