Estimating LGD with Stochastic Collateral

32 Pages Posted: 20 Jan 2014

See all articles by Robert Frontczak

Robert Frontczak

Landesbank Baden-W├╝rttemberg (LBBW)

Stefan Rostek

University of Tuebingen - Faculty of Economics and Business Administration

Date Written: January 19, 2014

Abstract

This article addresses to the appropriate modeling of loss given default (LGD) for the retail business sector. We assume small or mid-size loans that are assigned in a standardized way and collateralized by residential or commercial property. The focus on this specific type of loans entails two major advantages: Firstly, reduction of complexity is followed by easier-to-grasp methodology and increased handiness of results when comparing with other recent approaches in the field. Secondly, the focusing allows to take into account the characteristic properties of the housing market and its underlying uncertainty and so choose a tailor-made modeling for the collateral. The choice of an exponential Ornstein-Uhlenbeck diffusion as the stochastic process of the collateral combines the desirable features with the charm of analytical solvability which seems to be of advantage as regards to acceptance among practitioners. Further key improvements of this approach are the explicit consideration of loan ranking, the disentanglement of the time of default and the time of liquidation as well as the introduction of liquidation cost.

Keywords: Loss given default, Collateral, Real estate

JEL Classification: G12, G33

Suggested Citation

Frontczak, Robert and Rostek, Stefan, Estimating LGD with Stochastic Collateral (January 19, 2014). Available at SSRN: https://ssrn.com/abstract=2381552 or http://dx.doi.org/10.2139/ssrn.2381552

Robert Frontczak (Contact Author)

Landesbank Baden-W├╝rttemberg (LBBW) ( email )

Kleiner SchloBplatz 11
D-70173 Stuttgart, 70174
Germany

Stefan Rostek

University of Tuebingen - Faculty of Economics and Business Administration ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

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