Part2 Book 2 Operational Risk and Resiliency Page 312

lincoln40113

New Member
Hi David,

Would you recommend memorizing the two formulas in the circle (found in the attached), please?

Thank you David as always
 

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David Harper CFA FRM

David Harper CFA FRM
Subscriber
Hi @lincoln40113 Thanks for the question. I would recommend NOT memorizing them (to save shelf space in your brain!). If it helps, if it gives you any comfort, I do not have memorized either of those circled formulas. In regard to the correlation param, the text neglects to mention that the function serves to bound the correlation param in a range from 0.12 to 0.24 (such that, I think, the bottom two rows on Table 19.4 are nonsensical as the correlation cannot exceed 0.24). If you let a = [(1-exp(-50*PD)) / (1- exp(-50))], you'll notice this reduces to 0.12*a + 0.24(1-a) so that this is a weighting function between the two bounds.

Instead, what matters here (if anything) is the directional relationship between the variables, correlation and PD, and to a lessor extent the maturity adjustment. Semi-related, a recent discussion is here https://forum.bionicturtle.com/thre...re-the-global-financial-crisis-2nd-of-2.23287 because one of my quiz choices is the true/false statement "a. Under the Internal Ratings Based (IRB) approach to credit risk, default probability (PD) increases as the correlation parameter increases" ... as you know, I write deep questions, but in the 2020 review (i.e., 20.8.2. signifies a 2020 question), I was NOT going to ask for calculations here but only about the relationship. And you'll see in the thread how Evelyn asked (to me) an interesting follow-on. I hope that's helpful!
 
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