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Estimating expected loss given default in an emerging market: the case of Czech Republic

This article discusses the estimation of a key credit risk parameter – loss given default (LGD) – and calculates it for selected companies traded on the Prague Stock Exchange. The importance of estimating LGD stems from the fact that a lender‟s expected loss is the product of the probability of default, the credit exposure at the time of default, and the LGD. The Mertonian structural approach is used for LGD estimation. This technique makes it possible to derive LGD for publicly traded companies based on their debt and share prices. Our results indicate that the LGD has increased substantially during the current financial crisis, but not exceeding the levels reached over a decade ago, when the Czech Republic experienced rather unfavorable economic conditions. Next, we put forward that our resulting LGD calculated for main companies traded on the Prague Stock Exchange represents a lower estimate of this parameter for the entire corporate sector. This suggests that credit risk management strategies for the corporate sector should be more conservative than what our estimates imply.

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Article provided by Capco Institute in its journal Journal of Financial Transformation.

Volume (Year): 27 (2009)
Issue (Month): ()
Pages: 103-107

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Handle: RePEc:ris:jofitr:1390
Contact details of provider: Postal: 120 Broadway, 29th Floor New York, NY 10271
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Web page: http://www.capco.com/
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  1. Brian L. Betker, 1997. "The Administrative Costs of Debt Restructurings: Some Recent Evidence," Financial Management, Financial Management Association, vol. 26(4), Winter.
  2. Egert, Balazs & Kocenda, Evzen, 2007. "Interdependence between Eastern and Western European stock markets: Evidence from intraday data," Economic Systems, Elsevier, vol. 31(2), pages 184-203, June.
  3. Dvorak, Tomas & Podpiera, Richard, 2005. "European Union enlargement and equity markets in accession countries," Working Paper Series 0552, European Central Bank.
  4. Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
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