Developing an Impairment Loss Given Default Model Using Weighted Logistic Regression Illustrated on a Secured Retail Bank Portfolio

Douw Gerbrand Breed, Tanja Verster, Willem D. Schutte and Naeem Siddiqi
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Douw Gerbrand Breed: Centre for Business Mathematics and Informatics, North-West University, Potchefstroom 2531, South Africa
Tanja Verster: Centre for Business Mathematics and Informatics, North-West University, Potchefstroom 2531, South Africa
Willem D. Schutte: Centre for Business Mathematics and Informatics, North-West University, Potchefstroom 2531, South Africa
Naeem Siddiqi: SAS Institute Canada, Toronto, ON M5A 1K7, Canada

Risks, 2019, vol. 7, issue 4, 1-16

Abstract: This paper proposes a new method to model loss given default (LGD) for IFRS 9 purposes. We develop two models for the purposes of this paper—LGD1 and LGD2. The LGD1 model is applied to the non-default (performing) accounts and its empirical value based on a specified reference period using a lookup table. We also segment this across the most important variables to obtain a more granular estimate. The LGD2 model is applied to defaulted accounts and we estimate the model by means of an exposure weighted logistic regression. This newly developed LGD model is tested on a secured retail portfolio from a bank. We compare this weighted logistic regression (WLR) (under the assumption of independence) with generalised estimating equations (GEEs) to test the effects of disregarding the dependence among the repeated observations per account. When disregarding this dependence in the application of WLR, the standard errors of the parameter estimates are underestimated. However, the practical effect of this implementation in terms of model accuracy is found to be negligible. The main advantage of the newly developed methodology is the simplicity of this well-known approach, namely logistic regression of binned variables, resulting in a scorecard format.

Keywords: loss given default; weighted logistic regression; International Financial Reporting Standard 9; independence assumption (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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