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FRM Part II · FRM Exam Part II · Case Study: Model Risk and Model Validation

A validator wants to assess how sensitive a credit loss model is to its inputs. She shifts each key input, such as the unemployment rate and house price index, by a set amount one at a time and records the change in output. This technique is best described as:

This is sensitivity analysis. Changing one input at a time and observing the effect on model output shows how dependent results are on each assumption. Benchmarking compares against another model, backtesting compares forecasts with actual outcomes, and process verification checks implementation and data flows, so none of those describes the exercise.

  1. ASensitivity analysisCorrect
  2. BBenchmarking against an external model
  3. CBacktesting
  4. DProcess verification

Explanation

Varying inputs individually and observing output changes is sensitivity analysis, used to understand model behavior and the influence of assumptions. Benchmarking compares with another model, backtesting compares with actual outcomes, and process verification checks the operating process and data flows.

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