Unexpected Recovery Risk and LGD Discount Rate Determination

19 Pages Posted: 23 Jul 2009 Last revised: 6 Aug 2009

See all articles by Jiri Witzany

Jiri Witzany

University of Economics in Prague

Date Written: January 31, 2009

Abstract

The Basle II parameter called Loss Given Default (LGD) aims to estimate the expected losses on not yet defaulted accounts in the case of default. Banks firstly need to collect historical recovery data, discount the recovery income and cost cash flow to the time of default, and calculate historical recovery rates and LGDs. One of the puzzling tasks is to determine an appropriate discount rate which is very vaguely characterized by the regulation. This paper proposes a consistent methodology for the LGD discount rate determination based on estimation of the systematic, i.e. undiversifiable, recovery risk and a cost of the risk.

Keywords: credit risk, recovery rate, loss given default, discount rate, regulatory capital

JEL Classification: G21, G28, C14

Suggested Citation

Witzany, Jiri, Unexpected Recovery Risk and LGD Discount Rate Determination (January 31, 2009). 22nd Australasian Finance and Banking Conference 2009. Available at SSRN: https://ssrn.com/abstract=1438068 or http://dx.doi.org/10.2139/ssrn.1438068

Jiri Witzany (Contact Author)

University of Economics in Prague ( email )

Winston Churchilla Sq. 4
Prague 3, 130 67
Czech Republic

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