A Method for Assessing the IT Component of Model Risk and the Economic Capital to Cover It

Abstract

This paper considers the problem of assessing the information technology component of model risk (ITMR) and the amount of capital allocated to compensate for it. We develop a methodology to identify inconsistencies between the environments for the development and application of the model being implemented, taking into account risk factors such as errors made when writing the programme code of the model to operate in an industrial environment, poor data quality, and the inappropriate choice of system for the implementation of the model and/or the data source systems for its application. We propose a method for estimating the cost of the realisation of the ITMR assessment for a business organisation (the assessment is conducted on a model-by-model basis) and a method for calculating the economic capital to cover this risk. The method proposed may be used to control ITMR by analysing the amount of losses from its realisation, the probability of such realisation, and the cost of measures to reduce model risk.