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Model Risk Management: How to Avoid an Earnings Surprise

Fortnightly Magazine - December 2004

directly to the P&L.

Energy marketers' experience shows that common sense can go a long way to limit model risk (, "fast" MTM earnings are a rare occurrence and are more likely a reflection of mis-marking a deal). Common sense needs to be linked to a structured model risk management program to ensure models maintain integrity and to leave an audit trail of assumptions and changes.

Model risk grows exponentially where MTM accounting, illiquid markets, and complex products combine. These three features combine in power markets to create the perfect storm for model risk. When auditor liability is thrown into this storm, it generates a large, unavoidable cost that can be minimized only through dedicated corporate model risk-management action.

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