About the Impact of Model Risk on Capital Reserves: A Quantitative Analysis

This paper analyzes and quantifies the idea of model risk in the environment of internal modelbuilding. We define various types of model risk including estimation risk, model risk in distributionand model risk in functional form. By the quantification of these concepts we analyzethe impact of the modeling process of an econometric model on the resulting company model.Utilizing real insurance data we specify, estimate and simulate various linear and nonlinear timeseries models for the inflation rate and examine its impact on pension liabilities under the aspectof model risk. Under consideration of different risk measures it is shown that model risk can differprofoundly due to the specification process of the econometric model resulting in remarkablemonetary differences concerning capital reserves...