medium · FRM Part 2 Credit Risk
What is the primary reason why risk-neutral probabilities of default (PD) extracted from credit spreads are generally higher than physical (real-world) default frequencies?
- The use of equity volatility rather than asset value
- The violation of subadditivity in VaR risk aggregation results
- The presence of a default risk premium and liquidity premium
- The failure of the square-root-of-time rule when scaling volatility
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