Explanation:
Option D is false. At low correlations, the expected value of an equity tranche declines almost linearly with an increase in default rates, rather than being substantially positively convex. The equity tranche absorbs the first losses, so as default rates rise, its value drops straightaway until it is wiped out. Options A, B, and C are true statements regarding the behavior of equity tranches.
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With respect to the equity tranche, each of the following is true EXCEPT which is false?
A
For a given correlation, an increase in the default rate implies a lower (expected) equity tranche value
B
For a given default rate, an increase in correlation implies an increase in (expected) equity tranche value
C
For a given default rate, an increase in correlation implies a decrease in equity Credit VaR; but for a given correlation, a higher default rate implies an increase in equity Credit VaR
D
At low correlations, the equity value is substantially positively convex in default rates
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