Friday, August 01, 2014. 06:43 AM

My research papers, policy analysis and random thoughts on topics such as crisis, regulations and financial risk.

Jon Danielsson - London School of Economics

Model Risk of Risk Models

Jon Danielsson, Kevin R. James, Marcela Valenzuela and Ilknur Zer
April 2014

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 and caused by 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, with a no obvious way to identify which method is the best. Finally, we discuss the main problems in risk forecasting for macro prudential purposes and propose an evaluation criteria for such models.