Categories of |
Financial risk |
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Credit risk |
Market risk |
Liquidity risk |
Investment risk |
Business risk |
Profit risk |
Non-financial risk |
Valuation risk is the risk that an entity suffers a loss when trading an asset or a liability due to a difference between the accounting value and the price effectively obtained in the trade.
In other words, valuation risk is the uncertainty about the difference between the value reported in the balance sheet for an asset or a liability and the price that the entity could obtain if it effectively sold the asset or transferred the liability (the so-called "exit price").
This risk is especially significant for financial assets and related marketable contracts with complex features and limited liquidity, that are valued using internally developed pricing models. Valuation errors can result for instance from missing consideration of risk factors, inaccurate modeling of risk factors, or inaccurate modeling of the sensitivity of instrument prices to risk factors. Errors are more likely when models use inputs that are unobservable or for which little information is available, and when financial instruments are illiquid so that the accuracy of pricing models cannot be verified with regular market trades.[1]