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Downturn LGD: A Spot Recovery Approach

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  • Li, Hui

Abstract

Basel II suggests that banks estimate downturn loss given default (DLGD) to capture the systemic correlation between default rate and loss given default through economic cycles. However, previous approaches in the literature may not be internally consistent and may have bias in capital calculation. In this paper, we propose a new consistent model framework based on our recent work on stochastic spot recovery. We also compare numerically the downturn LGD in our model with some of the previous approaches.

Suggested Citation

  • Li, Hui, 2010. "Downturn LGD: A Spot Recovery Approach," MPRA Paper 71986, University Library of Munich, Germany, revised 30 Apr 2013.
    • Handle: RePEc:pra:mprapa:71986
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    References listed on IDEAS

    as
    1. Li, Hui, 2009. "On Models of Stochastic Recovery for Base Correlation," MPRA Paper 15750, University Library of Munich, Germany.
    2. Daniel Rösch & Harald Scheule, 2006. "A Multi-Factor Approach for Systematic Default and Recovery Risk," Springer Books, in: Bernd Engelmann & Robert Rauhmeier (ed.), The Basel II Risk Parameters, chapter 0, pages 105-125, Springer.
    3. Hui Li, 2013. "A Note On The Double Impact On Cva For Cds: Wrong-Way Risk With Stochastic Recovery," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(03), pages 1-14.
    4. Dirk Tasche, 2004. "The single risk factor approach to capital charges in case of correlated loss given default rates," Papers cond-mat/0402390, arXiv.org, revised Feb 2004.
    5. Jon Frye, 2000. "Collateral damage detected," Emerging Issues, Federal Reserve Bank of Chicago, issue Sep.
    6. Düllmann, Klaus & Trapp, Monika, 2004. "Systematic Risk in Recovery Rates: An Empirical Analysis of US Corporate Credit Exposures," Discussion Paper Series 2: Banking and Financial Studies 2004,02, Deutsche Bundesbank.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Basel II; Downturn Loss Given Default; Stochastic Recovery; Spot Recovery; Factor Credit Models; Default Time Copula; Gaussian Copula; Large Homogeneous Pool; Credit VaR; Expected Shortfall;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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