Model Risk versus Model Validation
From Open Risk Manual
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Model Risk versus Model Validation
Model Risk and Model Validation are related concepts but
- Model Risk refers to the potential for error in the development and implementation of a financial model and/or the application or interpretation of model results. In turn model errors can lead to a variety of financial and / or reputational loss events.
- Model Validation is the set of principles, practices and organizational arrangements supporting a rigorous (audited) model development and validation cycle.
Model Validation is necessary because of Model Risk (both conceptual and implementation issues) but does not eliminate it. Model validation is thus a Risk Mitigation activity and there is always a degree of Residual Risk