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

According to SR 11-7, which statement about the relationship between model risk and model uncertainty is most accurate?

Model risk cannot be eliminated because models are simplified representations of reality. SR 11-7 says it should be managed through limits on model use, ongoing monitoring, effective challenge and conservative adjustments. The guidance applies to vendor models and any decision-relevant models, not only in-house or capital models.

  1. AModel risk can be eliminated entirely through sufficient validation
  2. BBecause models are simplified representations of reality, model risk cannot be eliminated and should be managed through limits, monitoring and conservative adjustments where appropriateCorrect
  3. CModel risk applies only to models developed in-house, not vendor models
  4. DModel risk is relevant only to models used for regulatory capital

Explanation

SR 11-7 notes models are simplifications, so some risk always remains. It is managed by limits on use, monitoring, and conservative adjustments. The guidance also covers vendor models and all models used in decision making, not only regulatory capital models.

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