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A sound and independent model validation is essential for running reliable and robust risk management systems and methodologies. A comprehensive model validation framework with strong governance ensures effective identification of potential model risks related to models used at Eurex Clearing AG.
Eurex Clearing commits itself to a regular and thorough validation of all risk models along the model landscape.
Throughout the year, the independent model validation uses a number of validation instruments to regularly validate the conceptual soundness of the frameworks and adequacy of the risk models. At the end of the year an annual comprehensive validation is performed along the model landscape. In the annual validation report, all validation results obtained throughout the year are summarized and combined with a fundamental review of the methodology and the model parametrization. This yields an overall review of model performance and appropriateness. The report also assesses the effectiveness of processes and procedures relevant for managing model risks.
The adequacy of the initial margin is primarily validated by portfolio backtesting, which compares the initial margin with the actually realised profits and losses. The results are assessed using statistical tests. Validation at parameter level is performed by means of a parameter sensitivity analysis, which is conducted to determine the margin model's response to changes in model parameters. Results from backtesting and parameter sensitivity analysis are regularly reported to the Risk Committee in a form that does not breach confidentiality.
Offset monitoring ensures that portfolio diversification benefits granted by the portfolio margining approach stay within regulatory required limits and that Eurex Clearing is not exposed to further potential risks by the margin reduction. A model assumption materiality analysis reveals the materiality of assumptions made in margining models and is used as a tool to identify potential focus areas for further model improvement. The stressed period validation is used to analyse if the applied stressed periods within the Stress VaR component of Initial Margin are reasonable.
While portfolio backtesting is performed daily, the intervals for the validation of the other margining components differ between weekly, monthly and quarterly. The validation schedule allows for timely action in case the analysis results suggest that the model does not perform as expected.
Haircut backtesting is in place to validate the adequacy of haircuts on cash and non-cash collateral on a monthly basis. Results are also assessed using statistical tests. Also, the input parameters for Bond collateral are validated by means of a yield shift validation to ensure that the applied yield shifts used to calculate the haircuts are appropriate.
With the stress testing validation, the appropriateness of the stress testing methodology with all its components such as scenarios, parameters and assumptions is performed on an annual basis. Specifically, the adequacy of default fund calibration methodology is verified as a part of the stress testing validation. Anonymized results of the annual review are presented to the Risk Committee.
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