Model Validation – Stating the obvious

We’ve all heard the stories of how certain so-called market professionals have been able to book what proved fictitious profits because the bank they worked for had models which were pricing FX options significantly differently to the market. While it is true that opinions make markets, it is astonishing that this nefarious practice is still going on after the NAB debacle.

Some may choose to defend it as model arbitrage, but in reality, in some cases what is actually happening should be more accurately labelled as thieving. So I read with interest a recent report from consultancy firm Celent called Model Validation Best Practices: Achieving Value Added, authored by Umit Kaya and Il-Dong Kwon.

The report could have been sub-titled Stating the Bleeding Obvious, but that in no way detracts from it, for it highlights some pertinent truths about today’s financial markets.

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