![]() The Kupiec-POF test therefore attempts to assess model performance by comparing the amount of breaches a user would expect a model to produce with the actual amount it does. occasions whereby the P&L of a portfolio is greater than that predicted by the model). Indeed when specifying a model, users build-in expectations around its accuracy often defined by the number of breaches it produces (i.e. Risk models are not expected to produce reliable and robust risk estimates 100% of the time. What we already know about backtesting and the Kupiec-POF test This blog reveals that the distributional nature of the profit and loss (P&L) distribution being modelled can have a significant impact upon the previously known factors driving Type-II errors. the non-rejection of an incorrectly specified model). Given the clear systemic risk implications of employing an erroneous model, regulators and risk managers are often concerned with so-called “Type-II” errors (i.e. As with all forms of testing, the Kupiec-POF test has a degree of error associated with its use and under certain circumstances these errors may be substantial. The Kupiec-POF test represents the most widely-used test for assessing the reliability of these risk models (typically Value-at-Risk (VaR) models) – a process known as backtesting. Consequently, in a world in which risk models are used to calculate and exchange vast sums of capital and margin, the need for reliable tests is of paramount importance. ![]() ![]() Emmanouil Karimalis, Paul Alexander & Fernando Cerezetti.Īll models, including those which model financial risk, are in some sense “wrong” – they aim to “approximate” the real word but cannot possibly recreate it. ![]()
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