Modelling and estimating dependent loss given default

Martin Hillebrand proposes a portfolio credit risk model with dependent loss given default (LGD), offering a reasonable economic interpretation that is easily applicable to real data. He builds a precise mathematical framework, and stresses some important issues to consider when modelling dependent LGD

Most credit risk models assume loss given default (LGD) is a constant proportion of any credit loss, and ignore the fact that LGD is itself an important driver of portfolio credit risk because of its possible dependence on economic cycles. The Basel Committee on Banking Supervision (2004) acknowledged this importance by starting a discussion with the banking industry aimed at investigating this issue.

Empirical evidence for dependent LGD is provided by data presented in Altman et al (2003) and

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Credit risk & modelling – Special report 2021

This Risk special report provides an insight on the challenges facing banks in measuring and mitigating credit risk in the current environment, and the strategies they are deploying to adapt to a more stringent regulatory approach.

The wild world of credit models

The Covid-19 pandemic has induced a kind of schizophrenia in loan-loss models. When the pandemic hit, banks overprovisioned for credit losses on the assumption that the economy would head south. But when government stimulus packages put wads of cash in…

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