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FRM Part II · FRM Exam Part II · The Financial Stability Implications of Artificial Intelligence

Which mechanism best explains how AI-driven trading strategies could amplify market volatility during a stress event?

Correlated signals from similar models trained on similar data lead firms to sell at the same time, which withdraws liquidity and triggers fire sales and feedback loops, thereby amplifying volatility in stress.

  1. AModels trained on similar data generate correlated sell signals, causing simultaneous deleveraging and liquidity withdrawalCorrect
  2. BAI tools always provide liquidity to the market during stress, damping price moves
  3. CHuman oversight is increased, which slows reaction and causes price gaps
  4. DAI models eliminate leverage, which reduces fire sales

Explanation

If many firms' models respond to the same signals, they sell together, draining liquidity and causing fire sales and feedback loops. The other options assert effects that the FSB analysis does not support.

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