Model Risk Management

Model risk management addresses potential adverse consequences from decisions based on incorrect or misused models, including errors in model development, implementation, or application outside appropriate contexts. It encompasses model validation, performance monitoring, limitation documentation, and governance processes. Financial institutions face regulatory requirements for model risk management, particularly for credit, market, and capital models. A prominent example is the 2012 JPMorgan 'London Whale' trading loss, where flawed value-at-risk models and inadequate model governance contributed to over $6 billion in losses, highlighting the critical importance of robust model risk frameworks.