Model risk and uncertainty: a survey of the institutional landscape

Devajyoti Ghose and George Soulellis

Contents

Foreword

Preface

Acknowledgements

The evolution of models

The foundations of risk and uncertainty

Uncertainty: a taxonomy

Model risk and uncertainty: a survey of the institutional landscape

Model specification risk and uncertainty

Model operation risk and uncertainty

Data, models and their purpose

Artificial intelligence in finance: a synthesis of human and machine

A deeper dive into machine learning methods: their opportunities, limitations, risks and uncertainties

10.

Measurement of risk and estimation of uncertainty in prediction models

11.

Using models under risk and uncertainty

12.

When models fail

Epilogue: models and the future

Theseus encouraging his father, and speaking greatly of himself, as confident that he should kill the Minotaur, he gave the pilot another sail, which was white, commanding him, as he returned, if Theseus were safe, to make use of that; but if not, to sail with the black one, and to hang out that sign of his misfortune.

Plutarch’s Lives (translated by John Dryden)

4.1 INTRODUCTION

The Greek hero Theseus, who slew the Minotaur that was tormenting the citizens of Crete, specified a binary model to signal his return from the encounter with the fabled beast. As the famous myth states, he agreed with his father, King Aegeus, that upon his return he would fly a white sail indicating that he had indeed slain the Minotaur. A black sail, conversely, would mean that he had met his doom. And although he set sail victorious, his exuberance and excitement led him to forget the agreement with his father:

so great was the joy for the happy success of their voyage, that, neither Theseus himself, nor the pilot, remembered to hang out the sail which should have been the token of their safety to Aegeus, who, knowing nothing of their success, threw himself headlong from a rock, and perish’d in the sea.

(Dry

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