Model Risk & Validation

Valuation Service and Pricing Model Validation

Use our valuation services or let us verify yours

For instruments traded with sufficient liquidity, a quoted market price renders a discussion about “value” unnecessary. Quoted prices are intertwined with models based on the risk-neutral valuation concept and an absence of arbitrage: Models are used to produce a price, but observed prices are also used to calibrate those models.

But what about situations where no market prices can be observed? Does an investor’s preference have an impact on the price? Can one derive a pricing model for such a case, or choose between different pricing models competing for the job? What are the assumptions about the choice of variables used by the pricing algorithm and about the dynamics of the underlying factors?

Our Approach

With our valuation services we have developed a setup for testing pricing and risk models that allows the detection of hidden model problems for derivatives and structured products. It can be fine tuned to reflect a firm’s short or long term hedging strategy and reveals P&L bleeding and other problems that cannot be detected by classical model validation techniques.

Our Experience

• Monthly valuation of Insurance Linked Note to all investors throughout the lifetime of the note (several years)
• Validation of derivative pricing models for various asset classes including multi-factor and stochastic volatility models
• Development of pricing libraries used by financial services firms for benchmarking and model validation

Model Risk Management

Reducing and Monitoring the Risk Associated with Model Use

Model use affects the fortunes of firms in many ways, some of them unexpected. The risks can impact on the calculation of P&L movements, for example, or valuations, or the assessment of capital adequacy. There are also complex regulations – the 2011 OCC model governance guidelines. Fintegral helps clients ensure both best practice and compliance with the regulatory regime.

Our Approach

We subcategorise Model Risk into quantifiable and unquantifiable components. 

We address the quantifiable risks with our risk quantification reports, which deploy an arsenal of methods to estimate statistical and assumption risk. Control reviews then target the unquantifiable risk by applying a standardised list of required controls based on the model’s individual elements.

To facilitate these processes Fintegral consultants have developed a control tool which automates the creation of model maps, control reviews and model risk quantifications.

Our Experience

• Setting up a central model oversight function and implementation of a framework to assess model risk for a global tier 1 bank in Europe
• Performance of control reviews across a wide range of risk models including credit portfolio models, and models for liquidity, haircuts, stress and attrition
• Development and implementation of a governance framework and review of an economic capital and loan pricing tool for an international top-10 bank in Europe
• Model documentation reviews of pricing and other models for a major US bank, to ensure CCAR compliance
• 2016 benchmark survey of Model Risk Management practices among members of the International Association of Credit Portfolio Managers (IACPM)