Holooly Plus Logo
Holooly Plus Logo

Question 21.7: Repeat Problem 21.6 on the assumption that the probability o...

Repeat Problem 21.6 on the assumption that the probability of default applicable to all loans is uncertain. It is equally likely to be 0.5% or 1.5%.

The blue check mark means that this solution has been answered and checked by an expert. This guarantees that the final answer is accurate.
Learn more on how we answer questions.

In this case, we must average the cumulative binomial distributions for 0.5% and 1.5% loss probabilities. The probability of six or more defaults is 0.0021. This shows that introducing some correlation increases the tail risk.

Related Answered Questions

Question: 21.8

What is the autocorrelation for the default rates in Table 11.6, which can also be found on a spreadsheet on the author’s website? What are the implications of this for a Credit Risk Plus model? ...

Verified Answer:

The autocorrelation is quite high at 0.546. This s...
Question: 21.5

How can historical simulation be used to calculate a one-day 99% VaR for the credit risk of bonds in the trading book? What are the disadvantages? ...

Verified Answer:

Movements in credit spreads for all companies over...
Question: 21.6

A bank has 100 one-year loans, each with a 1% probability of default. What is the probability of six or more defaults, assuming independence? ...

Verified Answer:

Using the binomial distribution, the probability o...
Question: 21.4

Use the transition matrix in Table 21.1 and software on the author’s website to calculate a transition matrix for six months. What is the probability of a company rated Aaa staying Aaa during the six months? What is the probability of it moving to Aa? ...

Verified Answer:

The probability of an Aaa rating staying Aaa over ...
Question: 21.3

Use the transition matrix in Table 21.1 to calculate a transition matrix for two years. What is the probability of a company rated Aaa staying Aaa during the two years? What is the probability of it moving to Aa? ...

Verified Answer:

The probability of an Aaa rating staying Aaa over ...
Question: 21.2

Explain what is meant by the constant level of risk assumption. ...

Verified Answer:

The constant level of risk assumption assumes that...
Question: 21.1

Explain the difference between Vasicek’s model, the Credit Risk Plus model, and CreditMetrics as far as the following are concerned: (a) when a credit loss is recognized and (b) the way in which default correlation is modeled. ...

Verified Answer:

In Vasicek’s model and Credit Risk Plus, a credit ...