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FRM Part II · FRM Exam Part II · Supervisory Guidance on Model Risk Management

A bank developing a default model finds that the historical data for one key variable are sparse, so the developer substitutes a proxy series from a different portfolio. According to supervisory guidance on model development, what is the most appropriate treatment?

The developer should assess whether the proxy is relevant and representative of the target portfolio, document the rationale for using it, and disclose the limitations that result. Guidance requires data to be suitable for the model's purpose, so undocumented proxies or silent omissions are inappropriate.

  1. AUse the proxy without comment because proxies are always acceptable
  2. BDrop the variable and avoid mentioning the omission
  3. CAssess the proxy's relevance to the target portfolio, document the rationale, and disclose the resulting limitationsCorrect
  4. DReplace the entire dataset with the proxy series for consistency

Explanation

Guidance requires that data be suitable for the model's intended use, and that proxies be shown to be reasonably representative, with the rationale and limitations documented. Silent use or silent omission hides model risk, and replacing all data is unjustified.

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