Tiziano Bellini (Prometeia)

Model Risk Quantification in Commercial Banking: A Statistical Framework

Abstract :

A framework for quantifying model risks in commercial banking is proposed. Model Uncertainty is investigated from different angles with the aim to capture risks stemming from the model itself as well as its interaction with wider frameworks. As a first step we investigate model misspecification by assessing erroneous functional forms, ineffective variable selection, and calibration issues. Then the focus moves to model sensitivity to estimate the impact of either portfolio changes and external shocks. Finally, interactions among various models are scrutinized. Our final goal is to derive a distribution of indicators for summarizing the impact of model uncertainty on synthetic measures like bank’s economic, capital, liquidity ratios, and so on. Governance impacts are summarized in terms of the definition of a comprehensive model appetite framework with corresponding tolerance bands. Ex-ante assessment and continuous monitoring allow for a thorough improvement of the whole model risk management process.