medium · FRM Part 2 Credit Risk
A bank is modeling a 'Low-Default Portfolio' (LDP). It finds that in 10 years of history for Grade AAA, there have been zero defaults. If the bank uses the 'Pluto-Tasche' method to estimate a PD for its transition matrix, the result will be:
- A risk-neutral PD derived from the credit spreads of comparable high-grade bonds.
- A PD of exactly zero, which must then be adjusted using 'Expert Judgment' overlays.
- A conservative (non-zero) PD based on a specified confidence level (e.g., 95%).
- An immediate default probability of 0.001% as mandated by the Basel III floor.
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