FRM Part II · FRM Exam Part II · Credit Value at Risk
A portfolio manager uses CreditMetrics for a two-bond portfolio with each bond currently rated BBB. Compared with the case of zero asset correlation, what is the effect of raising the asset correlation between the two obligors to a high positive value, holding marginal transition probabilities fixed?
Expected portfolio value is unchanged because it depends only on each bond's marginal migration probabilities. Higher asset correlation increases the likelihood that both bonds are downgraded or default together, so portfolio value volatility and tail loss, and therefore credit VaR, increase.
- AExpected portfolio value falls and the standard deviation of value falls
- BExpected portfolio value is unchanged and the standard deviation of value rises, fattening the loss tailCorrect
- CExpected portfolio value rises and the standard deviation rises
- DExpected portfolio value is unchanged and the standard deviation falls
Explanation
Expected value of a sum is the sum of expected values, which depend only on marginal probabilities, so it is unchanged. Higher correlation raises joint migration to the same direction, increasing variance and the probability of simultaneous large losses, so credit VaR increases.
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