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

A bank's risk team reviews its internal credit scoring model. The model was built with a sound methodology and clean data, but business users have begun applying it to a new product segment for which it was never designed, and results are now unreliable. Which source of model risk does this best illustrate?

The best fit is incorrect use of the model outside its intended scope. The model was soundly built but is applied to a product segment it was never designed for, so unreliable results come from misuse rather than from flawed mathematics, coding, or development data.

  1. AIncorrect use of the model outside its intended scopeCorrect
  2. BMathematical error in the model's code
  3. CData entry errors in the development sample
  4. DInsufficient computing capacity during model run

Explanation

The model itself is sound, but it is being applied to a population it was not designed for. This is a model use (implementation) problem, not a fundamental error in construction. Coding errors and data errors concern development, which the scenario says were fine.

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