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

A bank licenses a vendor's proprietary pricing model whose code is not disclosed. According to SR 11-7, what is the most appropriate expectation for the bank?

The bank should still validate the vendor model as far as it can, using sensitivity analysis, benchmarking and outcomes analysis, and should require adequate vendor documentation. Model risk remains the bank's responsibility, and a lack of code access does not remove the need for validation.

  1. ASkip validation because the vendor is responsible for the model
  2. BValidate to the extent possible, using sensitivity analysis, benchmarking and outcomes analysis, and require vendor documentationCorrect
  3. COnly validate if the model produces losses
  4. DReplace the model with an in-house one

Explanation

SR 11-7 states vendor models must be validated like internal models as far as possible. The bank should obtain developmental evidence, run its own testing such as benchmarking and sensitivity analysis, and monitor outcomes. Responsibility for model risk remains with the bank, so skipping validation is wrong.

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