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

A risk manager is asked to describe an aggregate view of model risk across the firm to the board. Which approach is most consistent with supervisory guidance?

Aggregate model risk should consider individual models and their interactions, including shared assumptions, data and vendor dependencies, because errors can be correlated and compound. Simple counts, one-model proxies or independence assumptions understate firm-wide exposure, which is why guidance asks for an aggregate view reported to senior management.

  1. AReport only the number of models that failed validation in the past year
  2. BSum the individual model risk estimates assuming they are perfectly independent
  3. CConsider model risk both for individual models and in aggregate, accounting for interactions, shared assumptions and common data or vendor dependenciesCorrect
  4. DReport the model risk of the single most material model as a proxy for the firm

Explanation

Guidance states that model risk should be assessed in aggregate as well as for individual models. Models often share inputs, assumptions or vendors, so errors can be correlated and compound. Assuming independence or reporting only counts or one model understates aggregate exposure.

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