Case Study: Model Risk and Model Validation (FRM Part 2 2025 – Operational Risk – Ch 16)

FRM Part 2 – Operational Risk & Resilience (Ch.16): Case Study – Model Risk & Model Validation.
Learn what model risk is, where it comes from (execution vs. conceptual errors), and how to validate, monitor, and govern models in line with best practices. We review CAPM, VaR, GARCH, copulas, and famous case studies (Barclays–Lehman spreadsheet error, Mars orbiter unit mix-up) to extract lessons learned you can apply on exam day.

What you’ll learn

Model definition & key assumptions
Model risk management function (measurement, monitoring, tiers, governance)
Validation: backtesting, benchmarking, stress/scenario analysis

Updating models & communicating limitations
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After completing this reading you should be able to:
Define a model and describe different ways that financial institutions can become exposed to model risk.
Describe the role of the model risk management function and explain best practices in the model risk management and validation processes.
Describe lessons learned from the three case studies involving model risk.
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