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

A bank's model inventory lists a credit scoring model, a VaR model and a spreadsheet tool used to compute fair values of a few illiquid bonds. The head of risk proposes excluding the spreadsheet from the inventory because it is 'only a tool, not a real model'. Which response is most consistent with SR 11-7?

The spreadsheet belongs in the inventory. SR 11-7 defines a model broadly as any quantitative method that applies assumptions to input data to generate quantitative estimates, regardless of its form, technology, or whether it feeds regulatory capital. A fair-value spreadsheet meets that definition.

  1. AAgree, because only statistical models with estimated parameters are in scope
  2. BAgree, because models are in scope only if they feed regulatory capital
  3. CDisagree, because the definition covers any quantitative method that applies assumptions to input data to produce quantitative estimatesCorrect
  4. DDisagree, but only if the spreadsheet is built by an external vendor

Explanation

SR 11-7 defines a model broadly as a quantitative method, system or approach applying statistical, economic, financial or mathematical theories and assumptions to process input data into quantitative estimates. A spreadsheet producing fair values fits. Scope is not limited to statistical models, capital uses or vendor origin.

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