medium · Frm Part 2 Credit Risk
A risk manager is comparing transition matrices from two different rating systems. System X is Point-in-Time (PIT) and System Y is Through-the-Cycle (TTC).
During an unexpected economic downturn, how would the 'time-homogeneity' assumption most likely be challenged in System Y compared to System X?
- System Y will exhibit 'stabilities' in ratings, but the realized default rate for each grade will spike, indicating that the 1-year transition matrix is not time-homogeneous across the cycle.
- Both systems will perfectly maintain time-homogeneity because transition matrices are always calibrated to long-run averages.
- System X will show stable ratings but significantly higher realized default rates within each grade, violating homogeneity.
- System Y will show significant rating migration, violating homogeneity because the transition probabilities shift with the cycle.
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