The risk of loss from errors in a model or from using it wrongly. Validation and independent review control it.
Where you will meet it
Model risk comes up in 20 learning outcome notes across the FRM syllabus.
A few of them:
Introduction to Derivatives FRM Part I · Financial markets and products
“Model risk comes from valuing complex products with flawed assumptions, and operational risk from errors and unauthorised trading.”
Learning from Financial Disasters FRM Part I · Foundations of risk management
“London Whale (2012): model risk and weak governance.”
Calculating and Applying VaR FRM Part I · Valuation and risk models
“Its weaknesses are heavy computation, sampling error that falls only with the square root of the number of trials, and model risk, since the output is only as good as the assumed process and its parameters.”
Capital Structure in Banks FRM Part II · Credit risk measurement and management
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