Everything in this course is a model — and models fail. This note covers the governance discipline that financial institutions are now required to run around their models: what counts as a model (broader than you'd think — a spreadsheet calculator qualifies), what model risk is and the catastrophes that taught the industry to care (a wrong rate assumption cost NAB A$3 billion; a misused copula helped cause the GFC), how models are rated for materiality, and the full lifecycle from development through independent validation to decommissioning. This is qualitative material, but it is structured qualitative material — exam answers are marked on knowing the framework's components and applying them to a given model. The closing section turns the lens on this course's own models.
Learning objectives. By the end of this note you should be able to:
- give the SR 11-7 definition of a model (three components) and of model risk (two root causes);
- recount the case studies and the regulatory anchors (SR 11-7, CPS 220 ¶35(b));
- describe the materiality scoring dimensions and the High/Medium/Low consequence table;
- walk the model lifecycle end to end, including the validation tiers, ratings and roles;
- apply the framework to alpha, risk and pricing models.
In this lesson
- 5.1 What is a model, and what is model risk?
- 5.2 Materiality assessment
- 5.3 Lifecycle: development → validation → approval → monitoring
- 5.4 Alpha model risk
The full lesson, with worked examples and exercise solutions, is for members.
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