medium · FRM Part 2 Market Risk
A risk system models joint defaults with a Gaussian copula calibrated to normal-period correlations.
During a systemic crisis, what is the most likely outcome for the senior tranches of a credit portfolio compared to the model's predictions?
- Realized losses will exceed predicted losses because the model lacks tail dependence.
- Senior tranches will be unaffected as they are only sensitive to the mean loss of the pool.
- Predicted and realized losses will match as long as the correlation parameter is updated daily.
- Realized losses will be lower than predicted due to the diversification benefit of normal correlation.
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