Financial risk modeling

Risk modeling refers to the use of formal econometric techniques to determine the aggregate risk in a financial portfolio. Risk modeling is one of many subtasks within the broader area of financial modeling.

Risk modeling uses a variety of techniques including Value-at-Risk (VaR), Historical Simulation (HS), or Extreme Value Theory (EVT) in order to analyze a portfolio and make forecasts of the likely losses that would be incured for a variety of risks. Such risks are typically grouped into credit risk, liquidity risk, interest rate risk, and operational risk categories.

Many large financial intermediary firms use risk modeling to help portfolio managers assess the amount of capital reserves to maintain, and to help guide their purchases and sales of various classes of financial assets.

Formal risk modeling is required under the Basel II proposal for all the major international banking institutions by the various national depository institution regulators.