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Bayesian loss given default estimation for European sovereign bonds

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  • Jobst, Rainer
  • Kellner, Ralf
  • Rösch, Daniel

Abstract

We develop and apply a Bayesian model for the loss rates given defaults (LGDs) of European Sovereigns. Financial institutions are in need of LGD forecasts under Pillar II of the regulatory Basel Accord and the downturn in LGD forecasts under Pillar I. Both are challenging for portfolios with a small number of observations such as sovereigns. Our approach comprises parameter risk and generates LGD forecasts under both regular and downturn conditions. With sovereign-specific rating information, we found that average LGD estimates vary between 0.46 and 0.64, while downturn estimates lay between 0.50 and 0.86.

Suggested Citation

  • Jobst, Rainer & Kellner, Ralf & Rösch, Daniel, 2020. "Bayesian loss given default estimation for European sovereign bonds," International Journal of Forecasting, Elsevier, vol. 36(3), pages 1073-1091.
    • Handle: RePEc:eee:intfor:v:36:y:2020:i:3:p:1073-1091
    DOI: 10.1016/j.ijforecast.2019.11.004
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    2. Darracq Pariès, Matthieu & Müller, Georg & Papadopoulou, Niki, 2023. "Fiscal multipliers within the euro area in the context of sovereign risk and bank fragility," Economic Modelling, Elsevier, vol. 126(C).
    3. Son Tran & Peter Verhoeven, 2021. "Kelly Criterion for Optimal Credit Allocation," JRFM, MDPI, vol. 14(9), pages 1-16, September.

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