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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

In the 2012 JPMorgan 'London Whale' episode, which operational and model-risk failure contributed directly to understated risk in the Synthetic Credit Portfolio?

A new VaR model for the Synthetic Credit Portfolio was built on error-prone spreadsheets and not properly validated, understating risk by lowering measured VaR. The trades were genuine, not fictitious, so the failure was model risk and weak oversight rather than concealed unauthorized trades.

  1. AA new VaR model was implemented with spreadsheet errors that reduced the measured VaR, and was not adequately validatedCorrect
  2. BThe portfolio was exempt from VaR limits because it was held by a non-bank affiliate
  3. CThe trades were fictitious and booked by a single trader without approval
  4. DThe portfolio's losses were hidden by a lack of mark-to-market accounting

Explanation

JPMorgan's CIO adopted a revised VaR model that relied on manual spreadsheets with formula errors, understating VaR by roughly half, and it lacked proper validation. The trades were real and approved, so option C is wrong. The portfolio was subject to VaR limits, so B is wrong.

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