TITLE

A simulation study on the impact of correlation between LGD and EAD on loss calculation when different LGD definitions are considered

AUTHOR(S)
Lopes, Samuel Da-Rocha; Nunes, Tiago
PUB. DATE
March 2010
SOURCE
Journal of Banking Regulation;Mar2010, Vol. 11 Issue 2, p156
SOURCE TYPE
Academic Journal
DOC. TYPE
Article
ABSTRACT
This article examines, through a Monte Carlo simulation study, the impact of considering different Loss Given Default (LGD) definitions, as allowed by the regulation, in the accuracy of LGD calculation at portfolio level. The article suggests that the way the regulation is interpreted can have dramatic effects on LGD measurement and, consequently, on the capital that banks are required to hold for regulatory purposes. The findings herewith can be deemed quite robust given that they are observed under different Monte Carlo simulation settings – for Retail and Corporate portfolios, as well as for different phases of the economic cycle. The effect of introducing correlation between LGD and EAD is also analyzed. The implications of the findings presented in this article range from policy actions to the practical way banks determine LGD, encompassing also issues of level playing field and financial stability. Future research along the lines presented here can be extended to understand and, eventually, shed some additional light on the cyclicality of Basel II.
ACCESSION #
49382722

 

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