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on model validation: how?

proprietary “ABC approach” was published in Bank ALM in 2002

 

Assessment procedures

• “to help financial institutions mitigate potential risks arising from reliance on computer-based financial models that are improperly validated”
• we have “observed several instances in which decision makers either relied on erroneous price or exposure estimates, or on an overly broad interpretation of model results, with serious consequences for their bank’s reputation and profitability”
• “using unvalidated models to manage risks to the bank is potentially an unsafe and unsound practice”.

Benchmarking procedures

• “traditional relationships between market conditions and balance-sheet behavior have broken down in some cases”
• “advanced interest-rate risk measurement techniques can enhance measurement systems, (but) new techniques may be inappropriately implemented or applied”
• institutions should consider having new models validated to ensure that new techniques have been correctly implemented

Comparative procedures (back-testing)

• statistical analysis of the sensitivity of NIM components to market rates
• review existing back-testing
• establish back-testing regime and reporting

how: assessment procedures

 

qualitative approach to model validation

• review of ALM model suitability given likely risk exposures
• review of institution-specific implementation
  - data
  - assumptions
  - results & reporting
  - documentation

recommendations

– prioritized based on materiality
– specific implementation enhancements