FRM Part II · FRM Exam Part II · Credit Risk Management
Which approach best allows a bank to identify which individual loans contribute most to portfolio tail risk, so that concentration limits can be set accordingly?
Allocating economic capital using marginal or contribution to unexpected loss works best, because it reflects each loan's exposure size and its correlation with the rest of the portfolio, revealing which names drive tail risk and where concentration limits are needed.
- AComparing each loan's stand-alone expected loss
- BAllocating economic capital using marginal or contribution to unexpected lossCorrect
- CRanking borrowers by external rating only
- DAveraging default probabilities across the portfolio
Explanation
Risk contributions account for both exposure size and correlation with the rest of the portfolio, so they show which names drive tail risk. Stand-alone expected loss, ratings alone, or averages ignore the dependence structure.
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