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

A risk manager is asked to report aggregate model risk for the firm's 120 models. Which approach is most consistent with supervisory guidance?

Aggregate model risk should be assessed by considering how models interact, including common inputs, assumptions and vendors, since errors may compound or offset. Summing scores, assuming independence, or looking only at the largest model ignores these dependencies and understates the firm-wide exposure.

  1. ASum the individual validation scores of all models and report the total as the firm's model risk
  2. BAssess model risk in aggregate by considering interactions and shared inputs, assumptions or common vendors, including potential offsetting or compounding errorsCorrect
  3. CReport only the risk of the single largest model, since it dominates exposure
  4. DAssume model errors are independent so aggregate risk equals the average model risk

Explanation

The guidance says aggregate model risk should consider interdependencies, such as shared data, assumptions or vendor components, where errors can compound or offset. Simple summing or assuming independence ignores these links. Looking at only the largest model ignores concentration across many models.

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