FRM Part II · FRM Exam Part II · Advances in Artificial Intelligence: Implications for Capital Markets Activities
A market-making desk deploys a machine-learning model that updates bid-ask quotes in milliseconds based on order flow and inventory. Which risk is most directly heightened if many dealers deploy similar models trained on similar data?
The key risk is correlated behavior: if dealers use similar AI models and data, they may widen quotes or withdraw liquidity at the same time in stress, amplifying market illiquidity and volatility rather than diversifying responses.
- ACorrelated quoting behavior that withdraws liquidity simultaneously in stressCorrect
- BLower operational cost reducing profitability for all dealers
- CReduced need for model validation due to automation
- DElimination of inventory risk through faster quoting
Explanation
Similar models trained on similar data tend to react the same way to the same signals, so dealers may widen spreads or pull quotes together. This herding can amplify liquidity shocks. Inventory risk is not eliminated, and automation increases rather than reduces validation needs.
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