Benchmarking loss given default discount rates

Scheule, H; Jortzik, S

Benchmarking loss given default discount rates

Scheule, H

Jortzik, S

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Publisher:: Incisive Media
Publication Type:: Journal Article
Citation:: Journal of Risk Model Validation, 2020, 14, (3), pp. 53-96
Issue Date:: 2020

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Field	Value	Language
dc.contributor.author	Scheule, H https://orcid.org/0000-0001-7283-5654
dc.contributor.author	Jortzik, S
dc.date.accessioned	2020-12-16T02:48:25Z
dc.date.available	2020-12-16T02:48:25Z
dc.date.issued	2020
dc.identifier.citation	Journal of Risk Model Validation, 2020, 14, (3), pp. 53-96
dc.identifier.issn	1753-9579
dc.identifier.uri	http://hdl.handle.net/10453/144748
dc.description.abstract	This paper provides a theoretical and empirical analysis of alternative discount rate concepts for computing loss given default (LGD) rates using historical bank workout data. It benchmarks five discount rate concepts for workout recovery cashflows in order to derive observed LGDs in terms of economic robustness and empirical implications: contract rate at origination, loan-weighted average cost of capital, return on equity (ROE), market return on defaulted debt and market equilibrium return. The paper develops guiding principles for LGD discount rates and argues that the weighted average cost of capital and market equilibrium return dominate the popular contract rate method. The empirical analysis of data provided by Global Credit Data (GCD) shows that declining risk-free rates are in part offset by increasing market risk premiums. Common empirical discount rates lie between the risk-free rate and the ROE. The variation in empirical LGDs is moderate for the various discount rate approaches. Further, a simple correction technique for resolution bias is developed and increases observed LGDs for all periods, particularly recent periods.
dc.language	en
dc.publisher	Incisive Media
dc.relation.ispartof	Journal of Risk Model Validation
dc.relation.isbasedon	10.21314/JRMV.2020.225
dc.rights	info:eu-repo/semantics/embargoedAccess
dc.subject	1502 Banking, Finance and Investment
dc.title	Benchmarking loss given default discount rates
dc.type	Journal Article
utslib.citation.volume	14
utslib.for	1502 Banking, Finance and Investment
pubs.organisational-group	/University of Technology Sydney/Faculty of Business
pubs.organisational-group	/University of Technology Sydney/Strength - QFRC - Quantitative Finance Research Centre
pubs.organisational-group	/University of Technology Sydney/Faculty of Business/Finance Discipline
pubs.organisational-group	/University of Technology Sydney
utslib.copyright.status	open_access	*
pubs.consider-herdc	true
utslib.copyright.embargo	2021-09-11T00:00:00+1000Z
dc.date.updated	2020-12-16T02:48:11Z
pubs.issue	3
pubs.publication-status	Published
pubs.volume	14
utslib.citation.issue	3

Abstract:

This paper provides a theoretical and empirical analysis of alternative discount rate concepts for computing loss given default (LGD) rates using historical bank workout data. It benchmarks five discount rate concepts for workout recovery cashflows in order to derive observed LGDs in terms of economic robustness and empirical implications: contract rate at origination, loan-weighted average cost of capital, return on equity (ROE), market return on defaulted debt and market equilibrium return. The paper develops guiding principles for LGD discount rates and argues that the weighted average cost of capital and market equilibrium return dominate the popular contract rate method. The empirical analysis of data provided by Global Credit Data (GCD) shows that declining risk-free rates are in part offset by increasing market risk premiums. Common empirical discount rates lie between the risk-free rate and the ROE. The variation in empirical LGDs is moderate for the various discount rate approaches. Further, a simple correction technique for resolution bias is developed and increases observed LGDs for all periods, particularly recent periods.

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http://hdl.handle.net/10453/144748