Skip to content

FRM Part II · FRM Exam Part II · Credit Value at Risk

A risk analyst applies the Vasicek asymptotic formula to a bank's corporate book, which consists of only 25 large borrowers, with the top five making up 60% of exposure. Which statement best describes the likely effect on the capital estimate?

Capital is likely understated. The Vasicek formula assumes an infinitely granular portfolio in which idiosyncratic risk diversifies away completely. A book of 25 borrowers with heavy concentration retains significant name-specific risk, so tail losses exceed the formula's output unless a granularity adjustment is applied.

  1. ACapital is overstated because the model double counts diversification
  2. BCapital is unaffected because the formula depends only on PD and correlation
  3. CCapital is understated because the model assumes idiosyncratic risk is fully diversified awayCorrect
  4. DCapital is overstated because the model assumes perfect correlation among obligors

Explanation

The Vasicek formula assumes an infinitely granular portfolio, so only systematic risk remains. In a concentrated book, name-specific risk does not diversify, so actual tail losses exceed those implied by the formula. A granularity adjustment would be needed.

Did you get it right without looking?

One question tells you little. A timed set on Credit Value at Risk shows your real accuracy, how long you take and where you lose marks.

Practise Credit Value at RiskFree diagnostic mock

More Credit Value at Risk questions