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FRM Part II · FRM Exam Part II · Case Study: Model Risk and Model Validation

A bank discovers that a trading desk has been using a spreadsheet model with undocumented overrides, and the model owner has left the firm. Which action best fits sound model risk mitigation?

The bank should bring the spreadsheet into the model inventory, document it, assign ownership and validate it with controls proportionate to its risk. Profitable use is not evidence of soundness, spreadsheets that produce estimates count as models, and abrupt deletion without replacement creates new operational risk.

  1. AInclude the spreadsheet in the model inventory, document and validate it, and apply a tiering-based control proportionate to its riskCorrect
  2. BContinue using it unchanged because it has produced acceptable profits
  3. CDelete it immediately without replacement and leave the desk to estimate values manually
  4. DExclude it from the inventory because spreadsheets are not models

Explanation

Sound governance requires a comprehensive inventory, documentation, ownership and validation proportionate to risk, including end-user tools. Profits are not evidence of soundness, and excluding spreadsheets leaves unmanaged model risk. Abrupt deletion creates operational risk without a controlled replacement.

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