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4、If a risk manager assumes that the EMH is valid and that markets are efficient, the best way to manage model risk is to:

A) use models that are specific to each type of asset being valued. 
 
B) find a more sophisticated model. 
 
C) backtest models to ensure they work effectively using historical data.
 
D) use more than one model to value each asset to ensure that models come up with the same estimate of value. 

nayizhenfeng

The correct answer is B

Since the EMH assumes that the price of security will ultimately reflect the security’s true fundamental value, the risk that a model will not price a security correctly must mean that the model is not advanced or realistic enough to obtain the correct value. It follows that the best way to manage model risk under an EMH framework is to find a better or more sophisticated model.

nayizhenfeng

5、Which of the following is most likely a belief held by a risk manager that operates in a non-EMH framework for assessing model risk?

A) Simplistic pricing models will be less effective than complex models for estimating asset prices.
 
B) Model risk management is an exercise in determining how pricing methodologies may change in the future. 
 
C) Losses by a trader mean that a security’s price is moving away from its fundamental value, and the trader should be encouraged to add to the position. 
 
D) Pricing methodologies will change in an evolutionary way toward more sophisticated models. 

nayizhenfeng

The correct answer is B

A non-EMH framework means that the process for managing model risk becomes an exercise not in finding a model that will lead to a correct price, but in estimating how ways of deriving security prices in the future may differ from today’s commonly accepted wisdom.

nayizhenfeng

6、If an institution believes that the efficient market hypothesis does not hold, which of the following statements is TRUE?

A) The focus of traders is on identifying the model that produces true fundamental values.
 
B) The focus of traders is on identifying the model that produces today’s prices.
 
C) Deviations from an asset’s true fundamental value will be temporary.
 
D) The institution should seek a single model that serves both its trading and risk management functions.

nayizhenfeng

The correct answer is B

If the efficient market hypothesis does not hold, prices may not revert to a certain fundamental value. Thus, the focus is on finding a model that produces today’s prices rather than fundamental value. It is when the efficient market hypothesis does hold that traders and risk managers will seek a single model, because both will seek the same fundamentally correct price.

nayizhenfeng

7、When managing model risk, predicting how pricing methodologies may change in the future is:

A) important if one believes that the efficient market hypothesis does hold.
 
B) important whether or not one believes that the efficient market hypothesis holds.
 
C) never relevant in managing model risk.
 
D) important if one believes that the efficient market hypothesis does not hold.

nayizhenfeng

The correct answer is D

In a non-EMH framework the source of model risk shifts from finding the best model to how today’s pricing methodologies may change in the future.

Jarvia

谢谢