Skip to content

FRM Part II · FRM Exam Part II · Fundamentals of Credit Risk

An analyst notes that empirical transition matrices show rating momentum: issuers recently downgraded are more likely to be downgraded again than issuers with the same rating that did not just migrate. Which modeling assumption does this finding most directly contradict?

Rating momentum contradicts the Markov property. A Markov transition matrix assumes next-period migration depends only on the current rating, but momentum shows recently downgraded issuers are more likely to be downgraded again, so past migration history carries information.

  1. AThe Markov property of rating transitionsCorrect
  2. BThe assumption that default is an absorbing state
  3. CThe assumption that probabilities in each row sum to one
  4. DThe assumption that ratings are ordinal

Explanation

The Markov property says next-period migration depends only on the current rating, not on past path. Momentum shows history matters, violating it. Absorbing default, row sums, and ordinal ordering are not contradicted by momentum.

Did you get it right without looking?

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

Practise Fundamentals of Credit RiskFree diagnostic mock

More Fundamentals of Credit Risk questions