Downturn loss given default: Mixture distribution estimation

R Calabrese - European Journal of Operational Research, 2014 - Elsevier
European Journal of Operational Research, 2014Elsevier
The internal estimates of Loss Given Default (LGD) must reflect economic downturn
conditions, thus estimating the “downturn LGD”, as the new Basel Capital Accord Basel II
establishes. We suggest a methodology to estimate the downturn LGD distribution to
overcome the arbitrariness of the methods suggested by Basel II. We assume that LGD is a
mixture of an expansion and recession distribution. In this work, we propose an accurate
parametric model for LGD and we estimate its parameters by the EM algorithm. Finally, we …
Abstract
The internal estimates of Loss Given Default (LGD) must reflect economic downturn conditions, thus estimating the “downturn LGD”, as the new Basel Capital Accord Basel II establishes. We suggest a methodology to estimate the downturn LGD distribution to overcome the arbitrariness of the methods suggested by Basel II. We assume that LGD is a mixture of an expansion and recession distribution. In this work, we propose an accurate parametric model for LGD and we estimate its parameters by the EM algorithm. Finally, we apply the proposed model to empirical data on Italian bank loans.
Elsevier
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