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FRM Part II · FRM Exam Part II · Credit Scoring and Rating

A bank's credit portfolio manager observes that rating agency ratings of corporate issuers show strong rating persistence, with downgrades arriving slowly after market spreads have already widened. Which agency methodology feature best explains this behavior?

The lag arises because agencies deliberately pursue rating stability, changing a rating only when they judge the change in credit quality to be lasting rather than temporary. As a result, ratings adjust more slowly than credit spreads, which respond immediately to new information.

  1. AAgencies rate on a point-in-time basis and recalibrate daily to equity prices
  2. BAgencies use a rating-stability policy, changing ratings only when they believe a credit change is likely to be lasting rather than temporaryCorrect
  3. CAgencies are required to map each rating to a fixed, unchanging one-year default probability
  4. DAgencies base ratings only on the issuer's current-year accounting ratios without forward-looking judgment

Explanation

Agencies aim to avoid rating reversals, so they adjust only when a change in credit quality appears permanent. This causes lagging downgrades relative to market spreads. Daily recalibration to equity prices is not how agencies work, and ratings also include forward-looking judgment.

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