Market and model risks: a feasible joint estimate methodology

Mariano González-Sánchez (), Eva M. Ibáñez Jiménez () and Ana Isabel Segovia San Juan
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Mariano González-Sánchez: UNED (Universidad Nacional de Educación a Distancia)
Eva M. Ibáñez Jiménez: UNED (Universidad Nacional de Educación a Distancia)
Authors registered in the RePEc Author Service: Mariano Gonzalez Sanchez

Risk Management, 2022, vol. 24, issue 3, No 1, 187-213

Abstract: Abstract The increasing complexity of stochastic models used to describe the behavior of asset returns along with the practical difficulty of defining suitable hedging strategies are relevant factors that compromise the soundness and quality of risk measurement models. In this paper we define the risk model as the mispricing a consequence of using an inadequate model to describe asset behavior and we develop a least-squares Monte Carlo methodology to estimate market and model risk simultaneously. The results show that at different confidence levels and time horizons the proposed methodology to estimate the market and model risks has a greater joint explanatory power than the isolated estimate of market risk.

Keywords: Model risk; Simulation model; Stochastic process; Monte Carlo; Least-squares (search for similar items in EconPapers)
JEL-codes: C15 C35 C51 C52 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1057/s41283-022-00090-1

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