Higher default correlation implies that defaults are more likely to happen at the same time, which can lead to significant losses in the portfolio. In other words, if one borrower defaults, others are more likely to default as well, which amplifies the overall risk.

A is incorrect. Higher default correlation means that the defaults are more likely to occur together, which increases the risk. When defaults are correlated, adverse conditions affecting one borrower are more likely to affect others, potentially leading to simultaneous defaults, which increases the risk for the portfolio.

C is incorrect. Default correlation directly impacts credit portfolio risk because it affects the likelihood of multiple defaults occurring simultaneously, which can significantly influence the overall risk profile of the portfolio.

D is incorrect in the context of the general principles of credit risk. The relationship between default correlation and portfolio risk is a well-established concept in credit risk management.

Things to Remember

• A higher default correlation in a credit portfolio typically leads to increased risk, as it suggests a greater likelihood of joint defaults under adverse conditions.
• This phenomenon can significantly impact the risk profile and stability of the portfolio, particularly during market downturns.