Wednesday, 21 May 2008

About that model risk

On Monday I said:
The combination of leverage and complexity is a massive concentrator of model risk
By Wednesday we find in the FT:
Moody’s awarded incorrect triple-A ratings to billions of dollars worth of a type of complex debt product due to a bug in its computer models...after a computer coding error was corrected, their ratings should have been up to four notches lower.
The product was CPDOs. But that doesn't matter. This kind of thing will happen with leverage and complexity. A bug in the ratings model for French yoghurt companies might change the rating of Danone by one notch. But for structured stuff, it's likely to be a much bigger error.

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