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

In the JPMorgan Chief Investment Office 'London Whale' episode of 2012, the bank's VaR model for the Synthetic Credit Portfolio was changed in January 2012. Which feature of the model change best illustrates a model risk governance failure?

The London Whale case showed a governance failure because the revised VaR model was adopted without proper independent validation and, through manual spreadsheet errors and weak challenge, understated risk. It was not a vendor issue or a fully validated model hit by unusual markets.

  1. AThe new model was implemented without adequate independent validation and was later found to understate risk because of operational errors and weak controlsCorrect
  2. BThe new model was rejected by management because it produced higher VaR than the old model
  3. CThe change was made by an external vendor with no input from the bank's traders
  4. DThe model was validated fully and failed only because market volatility was unprecedented

Explanation

The post-mortem found the new VaR model was rolled out hastily, with insufficient review and spreadsheet-based manual errors, and it lowered reported risk. The control function did not challenge the change effectively. The other options contradict the documented facts.

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