Estimating LGD Correlation

Jiří Witzany

No 2009/21, Working Papers IES from Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies

Abstract: The paper proposes a new method to estimate correlation of account level Basle II Loss Given Default (LGD). The correlation determines the probability distribution of portfolio level LGD in the context of a copula model which is used to stress the LGD parameter as well as to estimate the LGD discount rate and other parameters. Given historical LGD observations we apply the maximum likelihood method to estimate the best correlation parameter. The method is applied and analyzed on a real large data set of unsecured retail account level LGDs and the corresponding monthly series of the average LGDs. The correlation estimate comes relatively close to the PD regulatory correlation. It is also tested for stability using the bootstrapping method and used in an efficient formula to estimate ex ante one-year stressed LGD, i.e. one-year LGD quantiles on any reasonable probability level.

Keywords: credit risk; recovery rate; loss given default; correlation; regulatory capital (search for similar items in EconPapers)
JEL-codes: C14 G21 G28 (search for similar items in EconPapers)
Pages: 15 pages
Date: 2009-09, Revised 2009-09
New Economics Papers: this item is included in nep-ecm and nep-rmg
References: Add references at CitEc
Citations: View citations in EconPapers (1)

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