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FRM Part II · FRM Exam Part II · Supervisory Guidance on Model Risk Management

Which of the following best captures why SR 11-7 says model risk increases with greater model complexity, broader use, and larger potential impact?

Model risk rises with complexity, uncertainty in inputs, wider use, and larger potential impact because these raise the chance and cost of decisions based on wrong or misused outputs. SR 11-7 therefore calls for governance and validation rigor proportionate to those factors.

  1. ABecause larger models always contain more programming bugs than simple ones
  2. BBecause these factors raise the likelihood and potential cost of adverse consequences from incorrect or misused outputs, so more rigorous governance is warrantedCorrect
  3. CBecause regulators prohibit complex models
  4. DBecause complex models cannot be validated

Explanation

SR 11-7 notes that model risk increases with complexity, input uncertainty, broader use, and larger potential impact, which is why validation and governance should scale accordingly. It does not ban complex models or say they cannot be validated, and bugs are only one source of risk.

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