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

A bank's market risk VaR model is validated by a team that reports to the head of the trading desk using the model. The validators are technically strong. What is the primary concern under supervisory model risk guidance?

The main concern is independence. Validators reporting to the head of the desk that uses the model face conflicts that can weaken objective challenge. Supervisory guidance expects validation to be separate from development and use, with appropriate incentives and influence, though external consultants are not mandatory.

  1. AValidation staff must hold advanced degrees in statistics
  2. BIndependence is compromised, because incentives and reporting lines may impair objective challengeCorrect
  3. CValidation must always be performed by an external consultant
  4. DValidation should be limited to outcomes analysis because conceptual soundness is the developer's responsibility

Explanation

Guidance requires validation to be independent of model development and use, with staff who have appropriate incentives and influence. Technical skill does not offset a conflict of interest. External validation is permitted but not required, and conceptual soundness is a core validation component.

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