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

A bank uses a vendor-supplied option pricing model whose code is proprietary and not disclosed. Which approach is most consistent with SR 11-7 expectations?

The bank should still validate the vendor model using documentation, benchmarking, sensitivity analysis and outcomes analysis, and apply compensating controls like limits or conservative adjustments. SR 11-7 holds the bank responsible for vendor models, so proprietary code does not remove the validation obligation.

  1. AValidate using available documentation, benchmarking, sensitivity and outcomes analysis, and set compensating controls such as limits and conservative overlaysCorrect
  2. BExempt the model from validation because the vendor is responsible
  3. CAccept the vendor's validation certificate as sufficient evidence
  4. DStop using any model whose source code cannot be reviewed

Explanation

SR 11-7 says vendor models remain the bank's responsibility and must be validated. Where code is opaque, banks should use testing, benchmarking, outcomes analysis, and controls to compensate. Reliance on the vendor's certificate alone or outright exemption is not acceptable, and a ban is not required.

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