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FRM Part II · FRM Exam Part II · The Financial Stability Implications of Artificial Intelligence

A bank's stress test assumes that asset correlations remain at their calibrated long-run average. Regulators warn that widespread AI adoption may alter market dynamics. Which adjustment to the bank's risk framework is MOST consistent with this concern?

The bank should add scenarios featuring correlation spikes and synchronised institutional behaviour, and reduce reliance on historical correlations, because AI-driven herding can make stress dependence far higher than the calibrated long-run average suggests.

  1. AAdd scenarios with correlation spikes and synchronised behaviour across institutions, and review reliance on historical correlationsCorrect
  2. BReplace all stress tests with a single historical VaR measure
  3. CAssume that AI adoption lowers correlations and relax limits
  4. DRely solely on vendor model validation reports

Explanation

If AI use can create herding, historical correlations may understate stress dependence. Forward-looking scenarios with correlation breakdowns address this. Relaxing limits or relying on vendors ignores the risk of common models and concentration.

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