medium · FRM Part 1

In the context of the 2007-2009 Financial Crisis, what was the primary 'model error' associated with the AAA ratings of senior mortgage-backed security tranches?

1. The models assumed that house prices would never decline nationally.
2. The models failed to account for the impact of rising interest rates on prepayments.
3. The models assumed default correlations were low and stable across different geographies.
4. The models used an inappropriately high recovery rate for subprime loans.

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