Scott is a credit analyst with one of the credit rating agencies in India. He was looking in Oil and Gas Industry companies and has presented brief financials for following 4 entities: Two credit analysts are discussing the DM-approach to credit risk modeling. They make the following statements: Analyst A: A portfolio's standard deviation of credit losses can be determined by considering the standard deviation of credit losses of individual exposures in the portfolio and summing them all up. Analyst B: I do not fully agree with that. Apart from individual standard deviations, one also needs to consider the correlation of the exposure with the rest of the portfolio so as to account for diversification effects. Higher correlations among credit exposures will lead to higher standard deviation of the overall portfolio.

Question

Scott is a credit analyst with one of the credit rating agencies in India. He was looking in Oil and Gas Industry companies and has presented brief financials for following 4 entities:  Two credit analysts are discussing the DM-approach to credit risk modeling. They make the following statements: Analyst A: A portfolio's standard deviation of credit losses can be determined by considering the standard deviation of credit losses of individual exposures in the portfolio and summing them all up. Analyst B: I do not fully agree with that. Apart from individual standard deviations, one also needs to consider the correlation of the exposure with the rest of the portfolio so as to account for diversification effects. Higher correlations among credit exposures will lead to higher standard deviation of the overall portfolio.

Quizplus · Accepted Answer

Analyst B is correct in stating that correlation among credit exposures needs to be considered to account for diversification effects. Higher correlations will lead to higher standard deviation of the overall portfolio. Therefore, option A is incorrect. Option C is correct as it considers both the individual standard deviations and correlation among credit exposures. So, only Analyst B is correct.

Scott Is a Credit Analyst with One of the Credit