Hi David,

What is meant by incremental prbability of default ?
Q the annual incremental prob of Def. of a bond is 15 % in year 1 and 20% in year 2.

Thanks
Sipani

Hi Sipani,

It’s not terminology to be found under our assignments; it is atypical. I *suppose* but I don’t know that it refers to what we (properly) call marginal or conditional PD (a.k.a., hazard or even default intensities. All four of those terms would be okay). Our assignments concern either:

* Marginal (or conditional) PD; e.g., the probability the bond defaults in the 3rd year conditional on survival through the end of years one and two. I suggest that is the concept you want to know (consistent with Saunders, Hull, Jorion)

* Cumulative PD; e.g., the probability the bond will default before the end of the 3rd year, that is, in either the 1st, 2nd, or 3rd year.

Where cumulative PD = 1 - probability [bond survives all three years] = 1 - [(1-marginal PD in first year)*(1-marginal PD in 2nd year)*(1-marginal PD in 3rd year)]

Probably inc’l refers to marginal but the logic of this above is more relevant frankly...David