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

A portfolio manager notes that during economic expansions, a rating agency's issuer ratings are rarely changed, but during sharp recessions many issuers are downgraded within a short period. Which characteristic of the agency's methodology best describes this pattern?

The pattern reflects a through-the-cycle approach. Ratings are kept stable during normal conditions and are adjusted only when long-run credit quality changes, so a severe recession triggers clustered downgrades. A point-in-time system would adjust gradually and continuously instead.

  1. AThrough-the-cycle rating approach with abrupt catch-up adjustments at turning pointsCorrect
  2. BPoint-in-time rating approach with ratings that fluctuate with every market price move
  3. CRating shopping by issuers selecting the most favourable agency
  4. DMapping of ratings to a fixed one-year default probability for every grade

Explanation

Through-the-cycle ratings aim for stability and change only when long-run credit quality shifts. When a severe downturn reveals a permanent deterioration, many downgrades occur together. Point-in-time ratings would move gradually and continuously, so option B contradicts the described pattern.

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