Explanation:
The correct answer is B.
The significant risk to highlight is the challenge of capturing jump-to-default risk when using historical simulation for Credit VaR calculations. This risk acknowledges the possibility that a company could default abruptly, which can have a considerable impact on the value of credit-sensitive instruments included in a portfolio.
A is incorrect. The assumption of continuously increasing credit spreads is not a primary concern of historical simulation methods; rather, the unpredictability of defaults is.
C is incorrect. While market liquidity risk is important, the discussion in question pertains to credit spread risk and its specific challenges, not the broader category of market risks.
D is incorrect. Interest rate risks are different from credit spread risks; the limitation discussed here is specific to the sudden default risk in credit spread risk adjustment.
Things to Remember
Ultimate access to all questions.
No comments yet.
Q.6026 In a meeting with senior management, a credit risk officer is explaining the challenges of adjusting Value at Risk for credit spread risk. What significant risk should the officer highlight when discussing the limitations of using historical simulation for Credit VaR calculations?
A
The risk of overestimating credit spread changes due to the assumption of continuously increasing spreads over time.
B
The challenge of capturing jump-to-default risk, which arises from the possibility that a company could default abruptly without prior indication.
C
The issue of underestimating market liquidity risk due to a narrow focus on credit spreads instead of the broader market impacts on portfolio value.
D
The limitations in assessing interest rate risks as historical simulation for Credit VaR is strictly confined to credit spread changes and neglects rate fluctuations.