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The Evaluation of Model Risk for Probability of Default and Expected Loss

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  • Gourieroux, Christian
  • Tiomo, Andre

Abstract

The quanti�cation of model risk is still in its infancy. This paper provides an operational quanti�cation of this risk for credit portfolio, when the objective is to approximate the average loss. The methodology is easy to implement and does not require the construction of any worst-case model. The required capital computed to cover for model risk depends on three components, that are an estimated impact of the incorrect model, an evaluated risk of inaccurate estimation of model risk and the prediction error hedge factor. The approach is illustrated by an application to a portfolio of corporate loans segmented by grades.

Suggested Citation

  • Gourieroux, Christian & Tiomo, Andre, 2019. "The Evaluation of Model Risk for Probability of Default and Expected Loss," MPRA Paper 95795, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:95795
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    File URL: https://mpra.ub.uni-muenchen.de/95795/1/MPRA_paper_95795.pdf
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    References listed on IDEAS

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    Cited by:

    1. Gourieroux, C. & Monfort, A., 2021. "Model risk management: Valuation and governance of pseudo-models," Econometrics and Statistics, Elsevier, vol. 17(C), pages 1-22.

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    More about this item

    Keywords

    Model Risk; Estimation Risk; Speci�cation Risk; Expected Loss; Probability of Default; Required Capital; Prudential Regulation; Difference Estimator. 1;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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