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Q.4406 The bank’s probability of default (PD) is estimated to be 0.01. What is the approximated value of the asset correlation in the context of the Basel II framework? | Financial Risk Manager Part 2 Quiz - LeetQuiz

Explanation:

Basel II model assumes the Lopez’s model given by:

\rho = 0.12 \left[ \frac{1 - e^{-50 \text{PD}}}{1 - e^{-50}} \right] + 0.24 \left[ 1 - \frac{1 - e^{-50 \text{PD}}}{1 - e^{-50}} \right]

Since we are given PD=0.01, then the asset correlation is given by:

\rho = 0.12 \left[ \frac{1 - e^{-50 \times 0.01}}{1 - e^{-50}} \right] + 0.24 \left[ 1 - \frac{1 - e^{-50 \times 0.01}}{1 - e^{-50}} \right] = 0.1928

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