The paper proposes a new approach to model risk measurement based on the Wasserstein distance between two probability measures. It formulates the theoretical motivation resulting from the interpretation of fictitious adversary of robust risk management. The proposed approach accounts for all alternative models and incorporates the economic reality of the fictitious adversary. It provides practically feasible results that overcome the restriction and the integrability issue imposed by the nominal model. The Wasserstein approach suits for all types of model risk problems, ranging from the single-asset hedging risk problem to the multi-asset allocation problem. The robust capital allocation line, accounting for the correlation risk, is not achievable with other non-parametric approaches.
The paper proposes a new approach to model risk measurement based on the Wasserstein distance between two probability measures. It formulates the theoretical motivation resulting from the interpretation of fictitious adversary of robust risk management. The proposed approach accounts for equivalent and non-equivalent probability measures and incorporates the economic reality of the fictitious adversary. It provides practically feasible results that overcome the restriction of considering only models implying probability measures equivalent to the reference model. The Wasserstein approach suits for various types of model risk problems, ranging from the single-asset hedging risk problem to the multi-asset allocation problem. The robust capital market line, accounting for the correlation risk, is not achievable with other non-parametric approaches.
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all alternative models and
equivalent and non-equivalent probability measures and
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and the integrability issue imposed by the nominal
of considering only models implying probability measures equivalent to the reference
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all
various
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allocation
market