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FRM Part II · FRM Exam Part II · Advances in Artificial Intelligence: Implications for Capital Markets Activities

Several large asset managers license the same foundation model from one provider to generate trading signals. A regulator warns that this raises financial stability concerns. Which combination of risks best describes the regulator's concern and an appropriate policy response?

The concern is correlated trading behavior and concentration in one third-party provider, which can amplify stress and create a single point of failure. Appropriate responses include monitoring provider concentration, stress testing common-model failure and bringing critical third parties under supervisory oversight.

  1. AIdiosyncratic credit risk at each manager; response is to raise each manager's dividend payout
  2. BCorrelated trading behavior and concentration in a single third-party provider, which can amplify market stress; response is monitoring of provider concentration, stress testing for common-model failure and oversight of critical third partiesCorrect
  3. CLower operating costs for managers; response is to subsidize adoption of the model
  4. DReduced market volatility from diversified signals; response is to remove all supervisory reporting

Explanation

Common models and data can produce herding and synchronized sell-offs, and reliance on one provider creates single-point-of-failure and concentration risk. Supervisors respond with third-party risk oversight, scenario analysis of common-model failure and monitoring of concentration. The other options misstate the risk or suggest irrelevant responses.

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