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

A bank uses five models that all depend on the same vendor's market data feed and the same vendor-supplied volatility surface. A flaw is discovered in the vendor's interpolation method. Which model risk concept does this best illustrate?

This illustrates correlated model risk from a common vendor dependency. One flawed vendor component spreads errors across several models at once, a concentration that model-by-model validation may miss, so firms should map shared inputs when aggregating model risk.

  1. ACorrelated model risk from a common vendor dependency, a concentration that individual validations could missCorrect
  2. BModel drift caused by changes in the bank's portfolio mix
  3. COverfitting in the bank's internal development
  4. DBenign diversification across independent models

Explanation

Several models share a single vendor component, so one flaw propagates across all of them. Validating each model separately may not reveal this concentration, which is why aggregate assessment should map common dependencies. Diversification does not apply because the errors are not independent.

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