Model Risk Analysis via Investment Structuring

TL;DR

This paper introduces a risk analysis method using Quantitative Structuring, which interprets risk as an investment opportunity to identify its sources and assess its materiality, demonstrated through options on vol-targeted indices.

Contribution

It presents a novel application of Quantitative Structuring for model risk analysis, linking risk sources directly to investment structures.

Findings

Identifies risk origins through investment structures

Quantifies risk materiality effectively

Demonstrates approach on options on vol-targeted indices

Abstract

"What are the origins of risks?" and "How material are they?" -- these are the two most fundamental questions of any risk analysis. Quantitative Structuring -- a technology for building financial products -- provides economically meaningful answers for both of these questions. It does so by considering risk as an investment opportunity. The structure of the investment reveals the precise sources of risk and its expected performance measures materiality. We demonstrate these capabilities of Quantitative Structuring using a concrete practical example -- model risk in options on vol-targeted indices.