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

A supervisor assesses a market where AI adoption has grown rapidly. Which combination of conditions would most increase the probability that AI-driven herding produces a destabilizing feedback loop?

Common models, shared data, similar risk limits that trigger simultaneous deleveraging, and thin liquidity together create the strongest feedback loop. Aligned behavior produces one-sided flow, and low liquidity turns it into large price moves that trigger further selling, amplifying instability.

  1. ADiverse model architectures, heterogeneous data, and strong human override
  2. BCommon foundation models, shared data vendors, similar risk limits triggering simultaneous deleveraging, and thin market liquidityCorrect
  3. CIndependent model validation and varied time horizons across firms
  4. DLow leverage and long-term investment horizons across participants

Explanation

Feedback loops need similar behavior, a common trigger, and limited capacity to absorb flow. Shared models and data align signals, similar limits synchronize selling, and thin liquidity makes prices move sharply, which feeds further selling. The other options reflect diversity or buffers that dampen feedback.

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