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

A bank uses a VaR model calibrated on a calm period to set limits for a newly launched exotic derivatives desk. Management wants to use unchanged model outputs. Which response BEST aligns with supervisory guidance on model use?

The bank should assess whether the model fits the new products, apply documented adjustments or conservatism, and monitor performance. Guidance ties validation to intended use, so a model approved for other desks cannot simply be extended to exotics without review of its limitations.

  1. AAssess whether the model is appropriate for the new products, apply documented adjustments or conservatism and limit-setting, and monitor performanceCorrect
  2. BUse the model unchanged because it was validated for other desks
  3. CDisable monitoring because the exotic products are small
  4. DReplace the model with unvalidated spreadsheets for flexibility

Explanation

Models must be used consistent with their intended purpose and validated scope. Extending to new products needs a fresh assessment of fit, with limitations understood and compensating adjustments or conservatism, plus ongoing monitoring. Prior validation for other desks does not cover this use.

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