AC948 Case Studies in Financial Environments Additions to Lecture 4

1
AC948 Case Studies in Financial Environments
Additions to Lecture 4

• Yuval Millo, AFM, U. of Essex

2
Model Risk 1

• Model risk may develop when
• The market has small number of large actors
• Actors are not unanimous
• If actors use similar models to plan their
  trading strategy, then trading may become,
  inadvertently, synchronised buying and selling
  will tend to occur simultaneously.
• As a result, overall price volatility may
  increase in such markets

3
Model Risk 2

• Model risk is a possible consequence of
  market-based risk management tools becoming a
  standard in investment firms.
• That is, model risk comes from the fact the
  dependence on mathematical models for risk
  assessment, in effect, created a market that is
  different from the market assumed in the models
  themselves.