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

A validator finds that a model's back-testing results look acceptable, but the model was developed on data from a benign period and its key assumption of stable correlations has not been examined. Which validation conclusion is most consistent with supervisory guidance?

Conceptual soundness remains deficient, so the model should carry limitations or compensating controls. Good back-test results from a benign period do not replace examining key assumptions such as stable correlations. Validation elements are complementary, and the validator must challenge assumptions rather than defer to developers.

  1. AOutcomes analysis alone is sufficient, so the model can be approved without limits
  2. BThe model should be rejected because back-testing is irrelevant
  3. CConceptual soundness remains deficient, so the model should have limitations or compensating controls despite good back-test resultsCorrect
  4. DOnly the developers can judge assumption validity, so the validator should defer

Explanation

Guidance stresses that the validation elements complement each other; good outcomes in a benign sample do not substitute for testing assumptions and limitations. The validator should flag the weakness and require limits, overlays or conservative use. Back-testing is relevant, not irrelevant, and deferring to developers breaches effective challenge.

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