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PRMIA 8010 Exam - Topic 4 Question 55 Discussion
Topic #: 4
Under the KMV Moody's approach to credit risk measurement, which of the following expressions describes the expected 'default point' value of assets at which the firm may be expected to default?
Recovery rates vary a great deal from year to year, and are difficult to predict. Therefore statement III is true. Similarly, any attempt to predict these is hamstrung by a high standard error, which can be as high as the historical mean itself. The error does not cancel itself out due to the effect of the business cycle making the error directionally biased. Thus statement IV is false.
Statement II is true as these are all factors that make forecasting recovery rates for any credit risk model rather difficult. Statement I is false because recovery rates are difficult to predict and assumptions are not easy to make.
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