FRM Part II · FRM Exam Part II · Credit Value at Risk
Two obligors each have a one-year PD of 5%. The joint default probability is 0.0075. What is the default correlation?
Default correlation equals joint default probability minus the product of the individual PDs, divided by the geometric mean of the Bernoulli variances. That gives (0.0075 - 0.0025)/0.0475, which is about 0.1053.
- A0.0500
- B0.1053Correct
- C0.0250
- D0.1500
Explanation
Correlation = (P12 - p1p2)/sqrt(p1(1-p1)p2(1-p2)). Numerator = 0.0075 - 0.0025 = 0.0050. Denominator = 0.05 x 0.95 = 0.0475. Result = 0.1053. Option 0.15 wrongly uses joint probability over PD without the product adjustment.
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