By: Thomas GriswoldWesternBanker Magazine

Some financial institutions regard model validations as required regulatory exercises. Financial models imitate reality and provide vital information to ensure successful strategic decision-making. Validations are an opportunity to improve the quality of the information provided, and thus the decisions based on it. A regular model validation should be more than a regulatory exercise. It should certify appropriate risk measurement and increase confidence in managing the institution.

At the very least, a validation confirms that model inputs lead to outputs that are in line with market expectations for value, risk, or projected earnings. Whether internal or external, the choice of model validator is partially responsible for the value realized from the process. Criteria to use when selecting a validator, whether internal or external, are strategic philosophy, the ability to comprehend market intelligence, and knowledge of market expectations.

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