Risk Model Validation: A Necessity
but also an Opportunity

Abstract

In April 2011, the Office of the Comptroller of the Currency (OCC) expanded long-standing guidelines titled, “Supervi sory Guidance on Model Risk Management.” The OCC issued these guidelines in response to the banking industry’s increasing reliance on modeling and analytics to drive decision making. Third-party model developers are accustomed to an annual validation to ensure that the proverbial “proof is in the pudding” and the model remains predictive even amid changing environments. In this article, the author provides a road map for risk management professionals that emphasizes and leverages the OCC’s guidance while identifying opportunities for portfolio performance enhancement. The article covers critical validation strategies, including ongoing monitoring, outcome analysis, back testing, benchmarking, stress testing, sensitivity analysis, and drill down.