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

A risk officer at an asset manager notes that many trading firms now license the same few third-party AI models to generate trading signals. Which financial stability concern is most directly raised by this development?

Widespread use of the same AI models makes firms' signals and trades more similar, which increases correlated positioning and herding. In stress, simultaneous selling can amplify price moves and volatility, so common-model dependence is a financial stability concern rather than a source of diversification.

  1. AGreater diversity of strategies, which reduces correlated positioning
  2. BIncreased correlation of trading behavior, which can amplify market moves and herding during stressCorrect
  3. CLower reliance on common data inputs, which reduces operational concentration
  4. DReduced market volatility because model signals cancel each other out

Explanation

When many firms rely on the same models or data, their signals and trades become more alike. This homogeneity raises herding and correlated selling, which can amplify shocks. The first option has the opposite effect, as reliance on common models reduces diversity rather than increasing it.

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