A Practical Guide to Market Risk Model Validations (Part I - Introduction)

The financial crisis of 2008 has been extremely challenging and, at the same time, illuminating period for market risk managers. The crisis revealed a convoluted nature of the market risk and put market risk models to the crash test. The epic failure of the risk management models culminated in a historic US credit rating downgrade on political risks and rising debt burden. In this paper series, we review common modeling issues and validation techniques used in the market risk management area. We focus on the pricing, hedging, value at risk (VaR), and counterparty credit risk (CCR) models. We discuss model risk events, market risk functional areas, common modeling issues, and model validation techniques. We have developed practical model validation procedures that should help validators to provide "effective challenge." The paper series also contains a number of real examples