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LGD and RR modeling - Comparison of models

LGD and RR modeling - Comparison of models Since Basel 2, a financial institution can determine the capital required for credit risk by using internal models, which require the determination of Loss Given Default (LGD). LGD is also an important element in assets pricing. The dynamics of LGD can be evaluated directly or can be extracted from the dynamics of the recovery rate (RR). Observed LGDs/RRs present an asymmetric and bimodal distribution. In this article several models formalizing these features are employed: simple models and models modeling the unusual nature of LGDs/RRs (skewed regressions, adjusted regressions, inflated regressions). In sum, 25 models were retained for evaluating the dynamics of LGDs and RRs and 13 covariates. Performances of models were compared by using several classical and advanced metrics determined by using 10-fold cross-validation. According to obtained results, the best way to forecast LGDs is either to model and forecast it directly with the beta regression and with the zero-adjusted beta regression or drawn it from the fitted and forecasted RRs with its performing models. These latter models are the beta regression and the one-adjusted beta regression. As expected, most of the retained explanatory variables influence the dynamics of LGDs/RRs. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Risk and Decision Analysis iospress

LGD and RR modeling - Comparison of models

Risk and Decision Analysis , Volume 8 (3-4): 25 – Oct 4, 2021

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Publisher
IOS Press
Copyright
Copyright © 2021 © 2021 – IOS Press. All rights reserved
ISSN
1569-7371
eISSN
1875-9173
DOI
10.3233/RDA-202063
Publisher site
See Article on Publisher Site

Abstract

Since Basel 2, a financial institution can determine the capital required for credit risk by using internal models, which require the determination of Loss Given Default (LGD). LGD is also an important element in assets pricing. The dynamics of LGD can be evaluated directly or can be extracted from the dynamics of the recovery rate (RR). Observed LGDs/RRs present an asymmetric and bimodal distribution. In this article several models formalizing these features are employed: simple models and models modeling the unusual nature of LGDs/RRs (skewed regressions, adjusted regressions, inflated regressions). In sum, 25 models were retained for evaluating the dynamics of LGDs and RRs and 13 covariates. Performances of models were compared by using several classical and advanced metrics determined by using 10-fold cross-validation. According to obtained results, the best way to forecast LGDs is either to model and forecast it directly with the beta regression and with the zero-adjusted beta regression or drawn it from the fitted and forecasted RRs with its performing models. These latter models are the beta regression and the one-adjusted beta regression. As expected, most of the retained explanatory variables influence the dynamics of LGDs/RRs.

Journal

Risk and Decision Analysisiospress

Published: Oct 4, 2021

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