The internal auditor began to worry about model risk. Putting a dollar figure on a particular risk is difficult, because it depends on the behavior of the parties using the model. For example, Kidder, Peabody's Government Trader system contained a tiny mistake that might have been insignificant, if traders had not done forward settlement out beyond corporate settlement. However, Joseph Jett did forward Treasury strips and recons that settled months into the future, which magnified the significance of the problem. The best way to manage model risk is to review models, document their weaknesses, and make sure that nobody uses the models in dangerous ways.
Every model is a simplification of reality.
If you push it far enough, it will fail. The challenge is to do that in a controlled environment that doesn't produce real losses. Puzzles Dr. Risk discusses issues like these in his classes on model risk. You notice it has a distinctly jagged look to it. In particular, it has saw teeth with peaks around five, seven, and ten years.