Which of the following statements regarding credit risk models is not true?

Question

BlackTom AI · Accepted Answer

Question restatement: The prompt asks which statement about credit risk models is not true, i.e., which option contains a false claim about how these models work.
Option 1: 'It distinguishes between default probability categories.' This is generally true, as many credit risk models categorize borrowers by levels of default probability (PD bands or rating/stage classifications) to tailor risk assessments and pricing.
Option 2: 'Credit risk models explain probabilities of payoff' This is incorrect. Credit risk models primarily aim to quantify the likelihood of default, exposure at default, and loss given default, so they focus on default probabilities and potential losses, not a general statement about 'probabilities of payoff' which is ambiguous and not the standard modeling target. One could misinterpret payoff as final repayment, but models are not defined to provide a standalone 'probability of payoff' in the way this option implies.
Option 3: 'Different parameters may be required for different industries.' This is true in practice. Industry-specific factors (economic conditions, sector-specific risks, collateral norms) often necessitate tailoring model parameters to capture differences across industries.
Option 4: 'The model requires its parameters to be updated.' This is true as credit risk models rely on evolving data (macro factors, borrower performance, new defaults) and typically require recalibration to maintain accuracy.
In summary, the only statement that misrepresents credit risk modeling is Option 2, which mischaracterizes the primary probabilistic focus of these models as 'probabilities of payoff' rather than probabilities of default and related loss measures.

25751 Financial Institution Management - Spring 2025 Week 7 Quiz

Which of the following statements regarding credit risk models is not true?

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