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FRM Part II · FRM Exam Part II · Credit Scoring and Retail Credit Risk Management

A lender builds a retail scorecard and wants a PD estimate that reflects the average default rate across a full economic cycle, rather than current conditions, so that capital requirements do not swing sharply with the cycle. Which approach does this describe?

This describes a through-the-cycle PD calibration. It targets the long-run average default rate across the economic cycle, which makes estimates and capital more stable. Point-in-time PDs instead respond to current conditions and make capital more procyclical.

  1. AA through-the-cycle PD calibrationCorrect
  2. BA point-in-time PD calibration
  3. CA downturn LGD calibration
  4. DA roll-rate transition analysis

Explanation

Through-the-cycle PDs are anchored to long-run average default rates and so are relatively stable across the cycle. Point-in-time PDs move with current conditions and make capital procyclical. Downturn LGD concerns loss severity, not PD.

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