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

Which practice best addresses explainability and model risk when a firm adopts a complex AI model for a capital markets function?

The best practice is independent validation combined with ongoing monitoring and human oversight, with limitations documented. This tests the model out of sample, detects drift early, and keeps accountability, whereas in-sample accuracy, removing humans, or reactive retraining leave model risk unmanaged.

  1. AIndependent validation, ongoing performance monitoring, and human oversight with documented limitationsCorrect
  2. BRelying solely on in-sample accuracy reported by the developer
  3. CRemoving human review to avoid subjective bias
  4. DRetraining the model only after a loss exceeds capital

Explanation

Sound model risk management requires independent validation, continuous monitoring for drift, and human oversight with clear documentation. In-sample accuracy alone overstates reliability, removing humans weakens control, and waiting for large losses is reactive rather than preventive.

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