  Darwinian model risk is the risk of mis-price-and-hedge biased toward
short-to-medium systematic profits of a trader, which are only the compensator
of long term losses becoming apparent under extreme scenarios where the bad
model of the trader no longer calibrates to the market. The alpha leakages that
characterize Darwinian model risk are undetectable by the usual market risk
tools such as value-at-risk, expected shortfall, or stressed
value-at-risk.Darwinian model risk can only be seen by simulating the hedging
behavior of a bad model within a good model. In this paper we extend to
callable assets the notion of hedging valuation adjustment introduced in
previous work for quantifying and handling such risk. The mathematics of
Darwinian model risk for callable assets are illustrated by exact numerics on a
stylized callable range accrual example. Accounting for the wrong hedges and
exercise decisions, the magnitude of the hedging valuation adjustment can be
several times larger than the mere difference, customarily used in banks as a
reserve against model risk, between the trader's price of a callable asset and
its fair valuation.
