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FRM Part II · FRM Exam Part II · Advances in Artificial Intelligence: Implications for Capital Markets Activities

A trading desk deploys a deep neural network to generate short-term signals. Validators find that the model performs well in backtests but its internal logic cannot be traced to specific input drivers. Which risk is most directly raised by this characteristic?

The main risk is lack of explainability. When a neural network's logic cannot be traced to specific inputs, validators and managers struggle to challenge, monitor and govern its outputs, even if backtest performance looks strong. Liquidity, settlement and interest rate risks are not directly caused by opacity.

  1. ALack of explainability, which makes it hard to validate, challenge and govern the model's outputsCorrect
  2. BLiquidity risk arising from the model's higher trading frequency
  3. CSettlement risk arising from delayed trade confirmations
  4. DInterest rate risk arising from duration mismatch

Explanation

Opaque models whose outputs cannot be tied to drivers are hard to validate, challenge and govern, which is the explainability problem. The other options describe unrelated risk types that are not caused by model opacity.

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