Most models were initially created for one specific purpose. Things start breaking
down when a model is used outside its range of usefulness. Applying an existing
model to a new field, a new product, or a new market should not be considered as a
straightforward operation, but must be performed as cautiously as the development
of a new model from scratch.
Many model risk issues happen when dealers extend an existing business or enter
a new one. They also attempt to recycle the models and tools with which they are
familiar. Unfortunately, a model can be good in one area and bad in another. As an
example, compare a pricing model versus a Value-at-Risk model. Pricing errors are
not translated in the Value-at-Risk estimates, since these focus only on price
variations and not on price levels. Therefore, a good model for Value-at-Risk will not
necessarily be a good pricing model!
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