What Is “Model Risk” for a Market Maker in Options?

Model risk is the potential for losses arising from the use of an inaccurate or improperly applied pricing or risk management model (e.g. Black-Scholes).

If the model miscalculates the fair value or the Greeks of an option, the market maker may quote an incorrect price or execute an insufficient hedge, leading to unexpected losses. This risk is especially high in nascent crypto markets.