Important Subtleties in Modelling Risk-Appetite and Economic Capital
The way that banks use portfolio credit risk models is often naive
As the world's banking and financial systems start to become stressed - there is sometimes a temptation to blame some of the risk models that are used by the banks. In the author's view these models are useful tools, but, particularly for credit risk, they do have a number of significant shortcomings, which need to be clearly understood by those using them.
These shortcomings are often compounded by the way in which these models are sometimes misused and misunderstood; and, of course, they cannot be used as a substitute for sound judgement. In this article the author describes some of the shortcomings that are often found in portfolio credit risk models.