# Model Risk ⎊ Area ⎊ Resource 3

---

## What is the Assumption of Model Risk?

This risk stems from the inherent limitations in the mathematical frameworks used to price complex derivatives, particularly when applying models designed for traditional finance to volatile, non-Gaussian crypto assets. Incorrect inputs regarding volatility structure or correlation introduce systematic mispricing. A failure to validate underlying premises leads to flawed valuation.

## What is the Calibration of Model Risk?

Errors in parameter estimation, such as volatility inputs or interest rate assumptions for perpetual funding, directly translate into inaccurate option premiums and Greeks calculations. Recalibrating these parameters frequently is necessary to reflect the rapidly evolving market microstructure of digital assets. Persistent calibration drift introduces significant unmanaged exposure.

## What is the Error of Model Risk?

The potential for the chosen pricing methodology to produce a valuation significantly different from the true market clearing price represents the realized consequence of this risk. For traders, this means that a theoretically "fair" trade based on their model might result in a loss when the position is closed in the actual market. Mitigating this requires robust backtesting against realized market data.


---

## [European-Style Options](https://term.greeks.live/definition/european-style-options/)

## [Financial Crisis Parallels](https://term.greeks.live/term/financial-crisis-parallels/)

## [Delta Calculation](https://term.greeks.live/term/delta-calculation/)

## [Economic Modeling Techniques](https://term.greeks.live/term/economic-modeling-techniques/)

## [Fat-Tailed Distribution](https://term.greeks.live/definition/fat-tailed-distribution-2/)

## [Option Adjusted Spread](https://term.greeks.live/definition/option-adjusted-spread/)

## [Portfolio Delta Hedging](https://term.greeks.live/definition/portfolio-delta-hedging/)

## [Rebalancing Risk](https://term.greeks.live/definition/rebalancing-risk/)

## [Reflexivity Theory](https://term.greeks.live/definition/reflexivity-theory/)

## [Asset Pricing](https://term.greeks.live/term/asset-pricing/)

---

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---

**Original URL:** https://term.greeks.live/area/model-risk/resource/3/