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Financ Mark Portf Manag (2012) 26:295296 DOI 10.1007/s11408-012-0182-5
B O O K R E V I E W
Published online: 4 April 2012 Swiss Society for Financial Market Research 2012
Understanding and Managing Model Risk: A Practical Guide for Quants, Traders and Validators, by Massimo Morini, examines the risks arising from the use of models in calibration, pricing, hedging, and extrapolation in various asset classes.
The author starts in Chap. 2 by presenting three case studies to analyze the impact of model risk in equity options (stochastic volatility vs. local volatility), rates (short-rate vs. market models), and credit (structural vs. reduced models). For the comparison of structural versus reduced form models, the author looks at a highly leveraged note on a reference entity. This note must be de-leveraged if a certain trigger occurs and sometimes the face value of the note may not cover the losses. Since in structural models, the default...