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The COVID-19 pandemic has caused unprecedented model failure and forecasting concerns across the financial industry. The widespread model deterioration cannot not be easily resolved by immediate redevelopment and recalibration effort, largely due to the unavailability of the outcome data before economic recovery reaches a stable state. Banks typically resort to overlays and management adjustments to correct large forecasting variances. This attempt could introduce additional noise and cause model estimates to become more volatile if shocks to the model cannot be self-absorbed in time or the overlay is poorly formed. In this article, I present a framework to evaluate overlay necessity using existing performance monitoring results and other factors, and identify opportunities for performance monitoring adjustments as transitory means for response to model deterioration before more permanent solutions can be implemented.
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