medium · Frm Part 2 Credit Risk
A bank's Internal Ratings Based (IRB) capital for a corporate exposure depends on the asset correlation (ρ).
If the regulator increases the assumed correlation from 0.15 to 0.25, while PD and LGD remain constant, what is the most likely impact on the 99.9% conditional default rate (PD_99.9)?
- PD_99.9 will increase linearly with the correlation coefficient.
- PD_99.9 will remain unchanged because it is a function of the through-the-cycle PD.
- PD_99.9 will decrease, as diversification benefits are higher at higher correlations.
- PD_99.9 will increase, as the tail of the systematic loss distribution becomes fatter.
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