The Short-term Perspective

Christian Meyer and Peter Quell

Part II of this book provides a general approach to the treatment of model risk. To implement this approach in financial institutions, this chapter will start by analysing QRMs in the context of market risk. Market risk is one of the main risk types of most financial institutions that are involved in trading activities. The dependence on QRMs for market risk has been strengthened increasingly by various initiatives from financial market regulators, such as Basel III (banking) or Solvency II (insurance). This has led financial institutions to embed market risk models in their steering processes as well as capital planning activities.

This chapter will start by briefly recalling the basic components of QRMs for market risk from earlier chapters. Since market risk models need to operate in an environment informed by financial market data, it is necessary to collect the essential characteristics of financial market time series. The descriptions of these “stylised facts” are mostly empirical in nature; thus, this chapter does not provide explanations for the observed behaviour in terms of other theories or models.

It will become clear that one of the most crucial assumptions