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

After a trading loss traced to a model that was used outside the product range for which it was designed, which control would most directly reduce the recurrence of this type of model risk?

Maintaining a model inventory that records intended use and limitations, and requiring approval for any new use, directly addresses misuse outside design scope. Other measures like bonus deferral or more complex models do not enforce appropriate use.

  1. AMaintaining a model inventory with documented intended use and limitations, with approval required for new usesCorrect
  2. BRaising traders' bonus deferral periods
  3. CIncreasing the frequency of daily P&L reporting
  4. DReplacing the model with a more complex one

Explanation

Misuse outside intended scope is controlled through an inventory, documented limitations and approval of new uses. Bonus deferral and P&L frequency do not enforce scope, and added complexity can raise model risk.

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