Credit Portfolio Loss Forecasts for Economic Downturns
Financial Markets, Institutions & Instruments, Vol. 18, No. 1, 2009, pp. 1-26
29 Pages Posted: 10 Nov 2013
Date Written: 2009
Recent studies find a positive correlation between default and loss given default rates of credit portfolios. In response, financial regulators require financial institutions to base their capital on 'Downturn' loss rates given default which are also known as Downturn LGDs. This article proposes a concept for the Downturn LGD which incorporates econ-ometric properties of credit risk as well as the information content of default and loss given default models. The concept is compared to an alternative proposal by the Department of the Treasury, the Federal Reserve System and the Federal Insurance Corporation. An empirical analysis is provided for US American corporate bond portfolios of different credit quality, seniority and security.
Keywords: Basel II, Business Cycle, Capital Adequacy, Corporate Bond, Correlation, Credit Risk, Economic Downturn, Expected Loss, Fixed Income, Loss Given Default,Probability of Default, Value-at-Risk
JEL Classification: G20, G28, C51
Suggested Citation: Suggested Citation