CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses
Following a large derivatives loss at a firm, an analyst concludes that the firm's valuation model relied on an unrealistic volatility assumption. The analyst is most likely identifying:
The analyst is identifying model risk, which is the chance of losses from relying on a flawed valuation or risk model or from unrealistic inputs such as volatility. It differs from operational risk, which stems from process or system failures, and from regulatory risk.
- Amodel risk.Correct
- Boperational risk.
- Cregulatory risk.
Explanation
Model risk is the risk of loss from using an incorrect or poorly specified valuation or risk model, including unrealistic inputs such as volatility. Operational risk concerns failures of people, processes or systems, and regulatory risk concerns rule changes.
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