Title: Model Risk Measurement under Wasserstein Distance,
Abstract: 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.