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FRM Part II · FRM Exam Part II · Estimating Default Probabilities

A bank compares through-the-cycle (TTC) ratings from an agency with point-in-time (PIT) ratings from its internal model during an economic downturn. Which outcome is most consistent with the difference between the two approaches?

Point-in-time ratings respond quickly to current conditions, so in a downturn they produce more downgrades and more procyclical capital requirements, whereas through-the-cycle agency ratings are designed to be more stable and look past temporary cyclical swings.

  1. ATTC ratings migrate more sharply with the cycle than PIT ratings, producing more procyclical capital requirements
  2. BPIT ratings are more stable than TTC ratings because they ignore current conditions
  3. CBoth approaches produce identical default probabilities for each grade at all times
  4. DPIT ratings react more quickly to the downturn, so internal ratings show greater downgrades and more procyclical capital than TTC ratingsCorrect

Explanation

PIT ratings incorporate current conditions and so migrate with the cycle, raising procyclicality. TTC ratings aim to look through the cycle and are more stable, with default rates per grade varying across the cycle.

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