Model Risk Measurement Under Wasserstein Distance

Yu Feng and Erik Schlogl
Additional contact information
Yu Feng: Finance Discipline Group, UTS Business School, University of Technology Sydney, http://www.uts.edu.au/about/uts-business-school/finance

No 393, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: The paper proposes a new approach to model risk measurement based on the Wasserstein distance between two probability measures. It formulates the theoretical motivation resulting from the interpretation of fictitious adversary of robust risk management. The proposed approach accounts for all alternative models and incorporates the economic reality of the fictitious adversary. It provides practically feasible results that overcome the restriction and the integrability issue imposed by the nominal model. The Wasserstein approach suits for all types of model risk problems, ranging from the single-asset hedging risk problem to the multi-asset allocation problem. The robust capital allocation line, accounting for the correlation risk, is not achievable with other non-parametric approaches.

Pages: 42 pages
Date: 2018-09-01
New Economics Papers: this item is included in nep-rmg
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Citations: View citations in EconPapers (3)

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https://www.uts.edu.au/sites/default/files/article/downloads/rp393.pdf (application/pdf)

Related works:
Working Paper: Model Risk Measurement under Wasserstein Distance (2019)
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