Q2. What is the implication in their context?
The implication in their context is that the KMV matrix will generate much more cyclicality in capital charges than a more stable rating agency matrix.
Q3. What is the way to dampen procyclicality?
Heavy-handed flattening of the capital formula might better succeed in dampening procyclicality, but also would distort relative capital charges across loans (and do so at every point in the business cycle).
Q4. What is the way to generate a smoothed regulatory requirement?
One simple method for generating a smoothed regulatory requirement Ĉit from the Cit is to apply an autoregressive (AR) filter:Ĉi,t = Ĉi,t−1 + α · (Ci,t − Ĉi,t−1).
Q5. What are the main reasons why through-the-cycle ratings are less useful for active portfolio management?
as through-the-cycle ratings are less sensitive to market conditions than point-in-time ratings, they are less useful for active portfolio management and as inputs to ratings-based pricing models such as Jarrow, Lando and Turnbull (1997).
Q6. Why did the IRB formula in CP3 have a declining functional relationship between PD?
This was motivated partly by the belief that smaller firms tend to be both higher in PD and lower in ρ than larger firms, which would implies a negative cross-sectional correlation between PD and ρ.
Q7. What is the primary objective of the simulations?
Their primary objective in the simulations is to explore the behavior of smoothing rules that are applied directly to the output of an unmodified IRB capital function.
Q8. Why does the CC rule disadvantage banks?
Because it depends only on the bank’s own time-series of IRB capital requirements, it does not disadvantage banks operating in local markets with business cycles distinct from the overall national market.
Q9. What is the average of the two smoothing rules across time?
The average (across banks) of the standard deviation of regulatory capital across time is 0.90% for CP3–PIT, and only 0.53% and 0.46% for the AR and CC smoothing rules, respectively.
Q10. What are some of the proposals that are called for dampening the inputs?
Some proposals call for dampening the inputs (that is, the PDs), some call for modifying the machinery (that is, by flattening the capital formula), and some call for dampening the outputs (that is, by loosening the relationship between the IRB capital formula and the required regulatory minimum).
Q11. What is the effect of the CP3–PIT series on the economic capital?
the two series track very closely, which suggests that little harm is done to the CP3–PIT capital requirement as a signal for changes in portfolio risk over time.