Risk-neutral default probability and real-world(or physical)default probability are used in the analysis of credit risk.Which one of the following statements on their uses is correct?
A.Real-world default probability should be used in scenario analyses of potential future losses from defaults,and real-world default probability should also be used in valuing credit derivatives.
B.Real-world default probability should be used in scenario analyscs of potential culture losses from defaults,but risk-neutral default probability should be used in valuing credit derivatives.
C.Risk-neutral default probabili1y should be used in scenario analyses ofpotential future losses from defaults,and risk-neutral default probability should also be used in valuing credit derivatives.
D.Risk-neutral default probability should be used in scenario analyses of potential future losses from defaults,but real-world default probability
should also be used in valuing credit derivatives.
Answer:B
A.Incorrect.Risk-neutral default probability should be used in valuing credit derivatives.
B.Correct.Real-world default probability should be used il1 scenario analyses of potential future losses from defaults,but risk-neutral default probability should be used in valuing Credit derivatives.
C.Incorrect.Real-world default probability should be used in scenario analyses ofpotential future losses from defaults
D.Incorrect.Real-world default probabi1ity should be used in scenario analyses of potential future losses from defaults(17 x 16/2)x(0.00508)2 X(1-0.00508)15=0.325%
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