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Case Study

Validation of an Interest Rate Model

FOCUS ON: Case studies,

SUMMARY

The client, a major European financial institution, requested the assistance of Avantage Reply in the review and validation of the Negative Interest Rates Model. This model estimates the potential losses of interest rate variability and supports negative interest rates.

Over the course of the project, Avantage Reply applied its expertise in model validation and worked in close liaison with both the first and the second line of defence in order to ensure comprehensiveness of the validation exercise.

CUSTOMERS GOALS

The bank was seeking support to carry out the initial validation (independent review) of the Negative Interest Rates Model, while ensuring the alignment of the exercise with the prevailing model validation standards and practices at the Bank.

THE CHALLENGE

The requested validation exercise had to evaluate the model from a fit-for-purpose perspective through a structured, comprehensive model validation methodology. Both qualitative assessment of the proposed methodology (including adequacy and fitness of the underlying theory for the intended purposes, validity of the involved assumptions, etc.) and quantitative assessment of the model (including accuracy of the implementation, sensitivity to model parameters, performance with respect to the relevant indicators, etc.) had to be performed.

APPROACH AND SOLUTION

The validation of the model have been performed by leveraging the expertise of Avantage Reply in the model risk management field and in accordance with the internal model validation standards.

As a result of the exercise, the Bank was provided with a comprehensive validation report, comprising a concise description of the model, an assessment of the model design and its fitness for purpose, an examination of the underlying assumptions, results of the model testing (including assessment of implementation correctness, sensitivity analysis, stress testing, etc.), suggested model performance evaluation approach, as well as an overall validation conclusion and a list of identified gaps and recommended actions.

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