A New Approach to Quantification of Model Risk for Practitioners

Zuzana Krajčovičová, Pedro Pablo Pérez-Velasco, Carlos Vázquez: Worldwide regulation obliges financial institutions to manage model risk with the same severity as any other risk. Its quantification is essential not only in meeting these requirements but also for institution's basic internal operative. In this article we address the quantification of model risk by the calculation of the norm of an appropriate function defined on a Riemannian manifold endowed with Fisher-Rao metric. The aim is twofold: introduce a sufficiently general and sound mathematical framework to cover the main points in model risk and illustrate how a practitioner may identify the relevant abstract concepts and put them to work.