Model validation
Institutions need to ensure that models used within their business are independently validated. This applies both to new models and the ongoing validation of existing models which need to be routinely calibrated to demonstrate their ongoing validity.
Institutions which have the scale and capacity may perform validation internally. For other institutions, whether for reasons of added independence or lack of internal capacity, it makes sense for models to be validated by an external third party.
Our model validation services cover a wide variety of model types, including:
- Pricing
- Market and credit risk for derivatives (e.g. VaR and Potential Future Exposure)
- Rating
- Basel: PD, LGD, EAD
- Economic capital
- Stress testing
We have a rigorous methodology for the validation of models. Alternatively, we can adhere to clients’ own model validation policies and standards.
Clients may wish to engage us on an ongoing basis to act as their validation provider, or on a one-off basis to validate specific models.
We can also build models ourselves or evaluate third party vendors of models to meet a client’s requirements – see our modelling services.
Client type
European investment bank
Location
UK
Client need
The client had an ongoing programme for the validation of pricing and risk analytic models. The models within the bank’s fixed interest derivative system were due to be validated, but the documentation for the models and the representation of products within the system was incomplete. The bank needed assistance in developing the validation programme. The products covered ranged from vanilla to exotics.
Our deliverables
Due to the lack of documentation much of the system and the models had to be reverse engineered. Once this had been done we produced a detailed validation plan in line with the client’s own validation policies.
Client
Retail banking division of large banking group
Location
UK
Client need
The bank was in the process of preparing the documentation for its Basel II waiver submission to the FSA. The documentation was prepared by each business unit and consolidated by a group function. The documentation pack amounted to several hundred documents and the group function needed to ensure the completeness, relevance and consistency of the documentation.
Our deliverables
We reviewed the documentation based on our Basel diagnostic tools. The review was designed to identify gaps in the documentation, inconsistencies and any areas of non-compliance with Basel rules. The deliverable was a detailed report which identified the areas where remedial action needed to be taken. The scope included all aspects of the Basel process including models for ratings, LGD, EAD, CCF, data and systems, management information and governance.
Client type
Wholesale division of European banking group
Location
UK
Client need
The client was in the early stages of considering upgrading its credit risk systems and the methodologies used in the calculation of exposure for its derivatives portfolio. The client wished to have its practices benchmarked against its peers and to have an independent assessment of the strategic direction it should take.
Our deliverables
We conducted a market intelligence study of the bank’s peers covering the methodologies used to calculate credit exposure and the risk systems used.
We benchmarked the client’s methodologies and systems against the market and recommended a strategic direction the bank should follow. This analysis included a comprehensive assessment of the various alternative methodologies, and sample portfolios were analysed under the alternative methodologies.
Client type
Private bank/asset manager
Region
Asia
Client need
The client wanted to be able to perform stress tests on its security portfolios to ascertain areas of excessive concentration.
Our deliverables
We developed a stress testing model which took into account asset correlations and liquidity. We also calculated appropriate stress parameters to be input into the model.