Model risk

Model risk is the risk that a model — whether statistical, computational, or conceptual — is not merely wrong but systematically misleading, concealing the very dangers it was designed to reveal. In finance, model risk is the dominant form of tail risk: the model that assigns a five-sigma probability to a market collapse makes the collapse invisible until it happens. In systems design, model risk is the architectural error of outsourcing vigilance to a tool that cannot see what the designer forgot to include. The ludic fallacy is the philosophical root of model risk: the belief that the world is a game with known rules. But the deeper threat is regime uncertainty — the possibility that the model's assumptions hold only in regimes that no longer exist.