Skip to content

FRM Part II · FRM Exam Part II · Estimating Default Probabilities

Empirical agency transition matrices generally show which pattern for investment-grade versus speculative-grade issuers over a one-year horizon?

Empirical transition matrices are diagonally dominant: the most likely one-year outcome is that the rating stays unchanged, with smaller probabilities for moves to adjacent grades and defaults rising as credit quality worsens.

  1. ARatings are most likely to stay unchanged, with probability mass concentrated on the diagonalCorrect
  2. BDowngrades are more likely than staying put for most ratings
  3. CUpgrades by two or more notches are the most common transition
  4. DDefault probability is highest for AAA because of concentration

Explanation

Empirical matrices are diagonally dominant: the most likely outcome in a year is no rating change, with smaller off-diagonal probabilities. Default probabilities rise as ratings worsen, not for AAA.

Did you get it right without looking?

One question tells you little. A timed set on Estimating Default Probabilities shows your real accuracy, how long you take and where you lose marks.

Practise Estimating Default ProbabilitiesFree diagnostic mock

More Estimating Default Probabilities questions