Understanding and Predicting Ultimate Loss-Given-Default on Corporate Debt

Posted: 27 Nov 2007 Last revised: 21 May 2011

See all articles by Michael Jacobs

Michael Jacobs

Accenture Consulting

Ahmet K Karagozoglu

Hofstra University, Zarb School of Business

Date Written: February 1, 2010

Abstract

Loss given default (LGD) is a critical parameter in various facets of credit risk modeling. This study empirically investigates the determinants of LGD and builds alternative predictive econometric models for LGD on bonds and loans using an extensive sample of most major U.S. defaults in the period 1985–2008. We build a simultaneous equation model in the beta-link generalized linear model (BLGLM) class, identifying several that perform well in terms of the quality of estimated parameters as well as overall model performance metrics. This extends prior work by modeling LGD both at the firm and the instrument levels. In a departure from the extant literature, we find the economic and statistical significance of firm-specific, debt, and equity-market variables. In particular, we find that information from either the equity or the debt markets at around the time of default (measures of either distress debt prices or cumulative equity returns, respectively) have predictive power with respect to the ultimate LGD, which is in line with recent prior recovery and asset pricing research. We also document a new finding, that larger firms have significantly lower LGDs while larger loans have higher LGDs.

Keywords: Recoveries, Default, Loss Given Default, Financial Distress, Bankruptcy, Restructuring, Credit Risk, Entropic Methods, Bootstrap Methods, Forecasting

JEL Classification: G33, G34, C25, C15, C52

Suggested Citation

Jacobs, Michael and Karagozoglu, Ahmet K, Understanding and Predicting Ultimate Loss-Given-Default on Corporate Debt (February 1, 2010). Available at SSRN: https://ssrn.com/abstract=1015331

Michael Jacobs (Contact Author)

Accenture Consulting ( email )

1345 Avenue of the Americas
New York, NY 10105
United States
9173242098 (Phone)

Ahmet K Karagozoglu

Hofstra University, Zarb School of Business ( email )

Department of Finance
134 Hofstra University
Hempstead, NY 11549
United States
(516) 463-5701 (Phone)
(718) 701-8331 (Fax)

HOME PAGE: http://people.hofstra.edu/ahmet_k_karagozoglu/

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