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Will Durant
04-29-2008, 02:13 PM
The official solution to this question doesn't make sense to me.

Transition matrix from BB to other ratings is given as:
AA - 1%
A - 2%
BB - 95.75%
B - 0.75%
C - 0.5%

Part b asks "Calculate the credit VaR at the 99% confidence level."

There is only a 0.5% chance that the bond will be rated C; there's a 99.5% chance that the bond will be rated B or higher.

Therefore, I would expect the correct answer to be
99% VaR = Value of BB bond - Value of B bond

But the SOA solution (and Carmody) give the answer as
99% VaR = Value of BB bond - Value of C bond

Does anybody understand this?

ETA - I can't believe this crap is my 5000th post! I hate the APM exam!! Down with the SOA!!!

TiderInsider
04-29-2008, 02:23 PM
The way I read it is that we have a 1.25% chance of being rated B or worse...that would correspond to credit VaR of 98.75%. Since we need to be at least 99% sure that we will lose no more than X dollars in the next year, we need the 1st percentile, which would correspond to being rated C or worse.

Car'a'carn
04-29-2008, 03:01 PM
The way I read it is that we have a 1.25% chance of being rated B or worse...that would correspond to credit VaR of 98.75%. Since we need to be at least 99% sure that we will lose no more than X dollars in the next year, we need the 1st percentile, which would correspond to being rated C or worse.

Goldfarb, explains it similarly and notes that this is the CreditMetrics approach.

The Smokin' Cracktuary
04-29-2008, 03:09 PM
The way I read it is that we have a 1.25% chance of being rated B or worse...that would correspond to credit VaR of 98.75%. Since we need to be at least 99% sure that we will lose no more than X dollars in the next year, we need the 1st percentile, which would correspond to being rated C or worse.

That is how I understood it, IIRC.