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

A developer selects a model's input data for a mortgage prepayment model and finds that the available history covers only a low-rate period. Which action is most consistent with supervisory guidance on model development?

The developer should assess whether the data is representative of the portfolio and the conditions where the model will be used, and document limitations and adjustments. A good in-sample fit does not prove suitability, and data weaknesses do not exempt a model from validation.

  1. AProceed, since any historical data is acceptable if the in-sample fit is high
  2. BAssess whether the data is representative of the portfolio and conditions in which the model will be used, and document the limitations and any adjustmentsCorrect
  3. CReplace the data with expert judgment and omit documentation to avoid inconsistencies
  4. DExclude the model from validation because data limitations are outside the model's scope

Explanation

Guidance requires developers to check that data is suitable and representative for the intended use and to document any proxies or adjustments. A high in-sample fit does not show the data covers relevant conditions. Skipping documentation or validation contradicts the guidance.

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