Analysing Model Risks in Risk Aggregation of Non-financial Corporations

This chapter deals with the identification and management of model risks for the risk aggregation process of non-financial corporations. Although model risk has been studied in quantitative models in the financial world, risk aggregation of companies from the real economy still has not been under extensive consideration. Companies outside the financial sector are also exposed to a risky business environment, for instance, induced by digitalisation and interconnectedness. The pandemic of the global coronavirus disease (COVID-19) threatened the existence of many companies, for example, sales markets collapsed and supply chains were interrupted. More than ever, calculating the overall risk exposure by aggregating the impact of risks plays an important role in the decision-making process and setting business strategy vis-à-vis macro uncertainty. However, managing model risk in risk aggregation assumes the company understands the aggregation process and its crucial details at risk. This research enhances model risk literature by introducing a structured in-depth analysis of details at risk. Thus, non-financial corporations are able to identify and prioritise details for model risk management purposes such as validation and monitoring. Additionally, this research outlines tools on how to control and manage model risks in the aggregation process by means of validation and governance.