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A Non-parametric Approach to Incorporating Incomplete Workouts Into Loss Given Default Estimates

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  • Rapisarda, Grazia
  • Echeverry, David
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    Abstract

    When estimating Loss Given Default (LGD) parameters using a workout approach, i.e. discounting cash flows over the workout period, the problem arises of how to take into account partial recoveries from incomplete work-outs. The simplest approach would see LGD based on complete recovery profiles only. Whilst simple, this approach may lead to data selection bias, which may be at the basis of regulatory guidance requiring the assessment of the relevance of incomplete workouts to LGD estimation. Despite its importance, few academic contributions have covered this topic. We enhance this literature by developing a non-parametric estimator that -under certain distributional assumptions on the recovery profiles- aggregates complete and incomplete workout data to produce unbiased and more efficient estimates of mean LGD than those obtained from the estimator based on resolved cases only. Our estimator is appropriate in LGD estimation for wholesale portfolios, where the exposure-weighted LGD estimators available in the literature would not be applicable under Basel II regulatory guidance.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 26797.

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    Date of creation: 16 Nov 2010
    Date of revision: 16 Nov 2010
    Handle: RePEc:pra:mprapa:26797

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    Keywords: Credit risk; bank loans; loss-given-default; LGD; incomplete observations; mortality curves;

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    1. Dermine, J. & de Carvalho, C. Neto, 2006. "Bank loan losses-given-default: A case study," Journal of Banking & Finance, Elsevier, vol. 30(4), pages 1219-1243, April.
    2. Dhaene, J. & Denuit, M. & Goovaerts, M. J. & Kaas, R. & Vyncke, D., 2002. "The concept of comonotonicity in actuarial science and finance: applications," Insurance: Mathematics and Economics, Elsevier, vol. 31(2), pages 133-161, October.
    3. Fuller, Russell J. & Kim, Sang-Hoon, 1980. "Inter-Temporal Correlation of Cash Flows and the Risk of Multi-Period Investment Projects," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(05), pages 1149-1162, December.
    4. Dhaene, J. & Denuit, M. & Goovaerts, M. J. & Kaas, R. & Vyncke, D., 2002. "The concept of comonotonicity in actuarial science and finance: theory," Insurance: Mathematics and Economics, Elsevier, vol. 31(1), pages 3-33, August.
    5. Altman, Edward I, 1989. " Measuring Corporate Bond Mortality and Performance," Journal of Finance, American Finance Association, vol. 44(4), pages 909-22, September.
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