Modelling and estimating dependent loss given default

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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