Coping with long term model risk in market risk models
- The recent financial crisis has shown that most market risk models – even if they deliver sufficiently accurate risk figures over short time horizons – are not able to provide reliable forecasts for risk figures over longer time horizons like three, twelve or 36 months, which are the basis for both limit management and economic capital planning. As a potential remedy the concept of potential future market risk can be used to deal with such long term model risks in market risk measurement. Based on a toy example we will outline how this concept can be applied for new business planning or for limit setting and capital buffer definitions.
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