Model risk of risk models |
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| Institution: | 1. Department of Finance and The Systemic Risk Centre, London School of Economics, Houghton St., London WC2A 2AE, UK;2. The Financial Markets Group and The Systemic Risk Centre, London School of Economics, Houghton St., London WC2A 2AE, UK;3. University of Chile (DII), Beauchef 851, Santiago, Chile;4. Federal Reserve Board, USA;1. Department of International Business Studies, National Chi Nan University, Nantou County, Taiwan, ROC;2. National Sun Yat-sen University, Kaohsiung, Taiwan, ROC;1. Department of Economics, City University London, Social Sciences Building, Northampton Square, London EC1V 0HB, UK;2. Department of Economics, City University London and Department d’Economia Aplicada, Universitat Autònoma de Barcelona, Edifici B Campus de la UAB, Cerdanyola del Vallès, 08193, Barcelona, Spain;1. Bureau of Economic Analysis, United States;2. School of Economics, University of Queensland, Australia;1. Swiss Finance Institute and University of Lausanne, Faculty of Business and Economics, CH 1015 Lausanne, Switzerland;2. University of Lausanne, Faculty of Business and Economics, CH 1015 Lausanne, Switzerland;1. Deutsche Bundesbank, Wilhelm-Epstein-Straße 14, 60431 Frankfurt am Main, Germany;2. Goethe University Frankfurt, Grüneburgplatz 1, 60323 Frankfurt am Main, Germany;1. Bank for International Settlements, Switzerland;2. European Central Bank, Germany |
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| Abstract: | This paper evaluates the model risk of models used for forecasting systemic and market risk. Model risk, which is the potential for different models to provide inconsistent outcomes, is shown to be increasing with market uncertainty. During calm periods, the underlying risk forecast models produce similar risk readings; hence, model risk is typically negligible. However, the disagreement between the various candidate models increases significantly during market distress, further frustrating the reliability of risk readings. Finally, particular conclusions on the underlying reasons for the high model risk and the implications for practitioners and policy makers are discussed. |
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| Keywords: | Model risk Systemic risk Value-at-Risk Expected shortfall Basel III |
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