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A Two Factor Model for PD and LGD Correlation

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  • Jiri Witzany

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Abstract

The paper proposes a two systematic factor model to capture a retail portfolio probability of default (PD) and loss given default (LGD) parameters, in particular their mutual correlation. We argue that the standard one factor models standing behind the Basel II formula and used by a number of studies cannot capture well the correlation between PD and LGD on a large (asymptotic) portfolio. The proposed model is implemented on real banking data giving an estimate of a positive PD and LGD correlation implied by the model slightly above 10%.

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File URL: http://ces.utia.cas.cz/bulletin/index.php/bulletin/article/view/183
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Bibliographic Info

Article provided by The Czech Econometric Society in its journal Bulletin of the Czech Econometric Society.

Volume (Year): 18 (2011)
Issue (Month): 28 ()
Pages:

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Handle: RePEc:czx:journl:v:18:y:2011:i:28:id:183

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Web page: http://ces.utia.cas.cz
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Related research

Keywords: credit risk; recovery rate; loss given default; correlation; regulatory capital;

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Cited by:
  1. Petr Gapko & Martin Smid, 2012. "Dynamic Multi-Factor Credit Risk Model with Fat-Tailed Factors," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 62(2), pages 125-140, May.
  2. Jiri Witzany, 2013. "Estimating Default and Recovery Rate Correlations," Working Papers IES 2013/03, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Apr 2013.

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