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AI Hallucination in Financial Systems: Threats, Controls, and the Future of Risk Management
Abstract
The adoption of Generative Artificial Intelligence (GenAI) in the global financial services sector is characterized by distinctive predictive analytics, customer service, and automation. However, it introduces a critical vulnerability: AI hallucinations, instances in which models generate outputs that are linguistically sound but factually incorrect or baseless. GenAI's capacity to fabricate data, misinterpret policies, or generate false market signals poses serious operational, reputational, and systemic risks. The chapter offers a detailed analysis of AI hallucinations in financial systems, covering definitions and a financial domain risk taxonomy. In addition, it examines the agency behind model failures. It also discusses the distinct threats that these models pose to a financial system. Additionally, the chapter introduces the Control Framework, which integrates Retrieval Augmented Generation (RAG) and other protocols. Finally, it examines the future of risk management, anticipating the development and evolution of regulations for stochastic models.
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