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Basel II suggests that banks estimate downturn loss given default DLGD in capital requirement calculation. There have been studies that model the dependence between default rates and losses given default through economic cycles. However, the models proposed are still not satisfactory due to the direct specification of term loss given default. In this paper, we propose a new model framework based on our recent work of stochastic spot recovery for Gaussian copula. We discuss the large homogeneous pool LHP limit and derive analytic formula for VaR and expected shortfall in the case of a single systematic factor. We also compare numerically the downturn LGD in our model with those of the previous approaches.

Item Type: MPRA Paper -

Original Title: Downturn LGD: A Spot Recovery Approach-

Language: English-

Keywords: Basel II, Downturn Loss Given Default, Stochastic Recovery, Spot Recovery, Factor Credit Models, Default Time Copula, Gaussian Copula, Large Homogeneous Pool, Credit VaR, Expected Shortfall-

Subjects: G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; GoodwillG - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing-

Author: Li, Hui


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