This is a piece of academic research very much needed at this point in time, where the regulatory obligations around internal model challenge have yet to formally land, let alone be adequately road-tested, while at the same time the UK is continuing with its ICAS+ regime, where entrants will no doubt receive running commentary on their progress in upscaling both assumption/parameter challenge as well as model use.
Anyone involved in the 200-ish pre-applications for internal model use prior to Solvency II go-live in Europe would therefore benefit from a read of this, particularly if you are on the validation-side. I picked out the following;
Fundamentals which impact on modelling choices (data sets, interpolation/extrapolation, correlations, tail dependencies etc)
- "We are not equally aware of all risks...people make decisions based on a subset of the available evidence"
- "Expectations are strongly influenced by personal experience and current events"
- Tendency to "...lose sight of infrequent losses" in the face of more frequent visible events
- Tendency to procrastinate around risks which are difficult to assess
- "Some may query the relevance of human factors, given the prevalence of quantitative risk models - the suggestion being.modelling rules out biases"
- "Low risk appetite can increase false alarms, and a high risk appetite increases misses"
- "The greater risk appetite of powerful individuals can stem from a tendency to focus more on rewards and successes, while people who are lacking in power are often more cautious and attentive to threats and potential obstacles" - is it this dichotomy which makes the role of the CRO ultimus inter pares in the boardroom?
Aide-memoire lists for risk practitioners
- How to counteract risk perceptions - p11
- Separating risk perceptions from immediate context - p13
- Awareness of bias linked to power - p16
- Risks in perspective - p20
- Behavioural principles which can create added value - p22