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Hi David,
Past Year 2006 FRM Question:
Which of the following statement on their uses is correct?
Answer: Real-world PD should be used in scenario analysis of potential future losses from defaults, but Risk-neutral PD should only be used in valuing credit derivative.
Queries:
Why we can't use Risk-neutral PD for scenario analysis since it is derived from CDS or bond prices?
Why Real-world PD could not be used to value credit derivative?
Your advice, please
Regards
Learning
I copied Q&A of Hull.23.06 for convenience purpose.
Hull.23.06 : Explain the difference between risk-neutral and real-world default probabilities.
Answer:
Risk-neutral default probabilities are backed out from credit default swaps or bond prices.
Real-world default probabilities are calculated from historical data.
Past Year 2006 FRM Question:
Which of the following statement on their uses is correct?
Answer: Real-world PD should be used in scenario analysis of potential future losses from defaults, but Risk-neutral PD should only be used in valuing credit derivative.
Queries:
Why we can't use Risk-neutral PD for scenario analysis since it is derived from CDS or bond prices?
Why Real-world PD could not be used to value credit derivative?
Your advice, please
Regards
Learning
I copied Q&A of Hull.23.06 for convenience purpose.
Hull.23.06 : Explain the difference between risk-neutral and real-world default probabilities.
Answer:
Risk-neutral default probabilities are backed out from credit default swaps or bond prices.
Real-world default probabilities are calculated from historical data.
