Intrinsic Model Risk

From Open Risk Manual

Definition

Intrinsic Model Risk refers to a subset of potential causes of Model Risk that is generated by the multiplicity of possible alternative models that are compatible with any available constraints.

Intrinsic model risk is distinct from many other causes categorized in the Model Risk Taxonomy in that it is irreducible: By definition it is not possible to limit that variability using further data and / or other information.

Causes

Causes will typically be reflecting the particular mathematical structure of a model class. Indicatively:

  • Inconclusive / inappropriate / incomplete variable selection in describing the system
  • Inadequate description of system dynamics
  • Different possible distributional assumptions

Mitigation

Given its intrinsic nature, this type of model risk may be difficult to reduce. Nevertheless recognition and management may be possible through limits

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