Validation
CA-14.13.25
Banks must apply the validation principles (see Section CA-14.12) in designing, testing and maintaining their IRC models. This includes evaluating conceptual soundness, ongoing monitoring that includes process verification and benchmarking, and outcomes analysis. Some factors that should be considered in the validation process include:
(a) Liquidity horizons should reflect actual practice and experience during periods of both systematic and idiosyncratic stresses;(b) The IRC model for measuring default and migration risks over the liquidity horizon should take into account objective data over the relevant horizon and include comparison of risk estimates for a rebalanced portfolio with that of a portfolio with fixed positions;(c) Correlation assumptions must be supported by analysis of objective data in a conceptually sound framework. If a bank uses a multi-period model to compute incremental risk, it should evaluate the implied annual correlations to ensure they are reasonable and in line with observed annual correlations. A bank must validate that its modelling approach for correlations is appropriate for its portfolio, including the choice and weights of its systematic risk factors. A bank must document its modelling approach so that its correlation and other modelling assumptions are transparent to the CBB;(d) Owing to the high confidence standard and long capital horizon of the IRC, robust direct validation of the IRC model through standard back-testing methods at the 99.9%/one-year soundness standard will not be possible. Accordingly, validation of an IRC model necessarily must rely more heavily on indirect methods including but not limited to stress tests, sensitivity analyses and scenario analyses, to assess its qualitative and quantitative reasonableness, particularly with regard to the model's treatment of concentrations. Given the nature of the IRC soundness standard such tests must not be limited to the range of events experienced historically. The validation of an IRC model represents an ongoing process in which the CBB and banks jointly determine the exact set of validation procedures to be employed; and(e) Banks should strive to develop relevant internal modelling benchmarks to assess the overall accuracy of their IRC models.Added: January 2012
