The Analytics of Risk Model Validation

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The validation of equity portfolio risk models

Stephen Satchel** Faculty of Economics, University of Cambridge and Trinity College, Cambridge, UK

Abstract

The purpose of this chapter is to survey risk validation issues for equity portfolio models. Because risk is measured in terms of volatility, an unobservable time-varying variable, there are a number of difficulties that need to be addressed. This is in contrast to a credit risk model, where default or downgrading is observable. In the past, equity risk models have been validated rather informally, but the advent of Basel II has brought about a need for a more formal structure. Furthermore, a number of past high-profile court cases have considered the worthiness of the risk models used by fund ...