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PRMIA Exam 8010 Topic 2 Question 63 Discussion
Topic #: 2
If the odds of default are 1:5, what is the probability of default?
Concentration risk in a credit portfolio arises due to a high degree of correlation between the default probabilities of the issuers of securities in the portfolio. For example, the fortunes of the issuers in the same industry may be highly correlated, and an investor exposed to multiple such borrowers may face 'concentration risk'.
A low degree of correlation, or independence of individual defaults in the portfolio actually reduces or even eliminates concentration risk.
The fact that issuers are from the same country may not necessarily give rise to concentration risk - for example, a bank with all US based borrowers in different industries or with different retail exposure types may not face practically any concentration risk. What really matters is the default correlations between the borrowers, for example a lender exposed to cement producers across the globe may face a high degree of concentration risk.
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