The Impact Of Systemic Loss Given Default On Economic Capital | Zendy

Jenni Van Dyk | Zendy; Jaun Lange | Zendy; Gary van Vuuren | Zendy

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The Impact Of Systemic Loss Given Default On Economic Capital

Author(s) -

Jenni Van Dyk,

Jaun Lange,

Gary van Vuuren

Publication year - 2017

Publication title -

international business and economics research journal (iber)

Language(s) - English

Resource type - Journals

eISSN - 2157-9393

pISSN - 1535-0754

DOI - 10.19030/iber.v16i2.9884

Subject(s) - loss given default , default , systemic risk , capital requirement , economics , loan , business cycle , monetary economics , recession , portfolio , capital (architecture) , point (geometry) , probability of default , econometrics , business , finance , microeconomics , credit risk , macroeconomics , financial crisis , profit (economics) , mathematics , history , geometry , archaeology

Empirical studies have demonstrated that loan default probabilities (PD) and loss given defaults (LGD) are positively correlated because of a common, business cycle, dependency. Regulatory capital requirements demand that banks use downturn LGD estimates because the correlation between PD and LGD is not captured. Economic capital models are not bound by this constraint. We extend and implement a model which captures the PD and LGD correlation by exploring the link between defaults and recoveries from a systemic point of view. We investigate the impact of correlated defaults and resultant loss rates on a portfolio comprising default-sensitive financial instruments. We demonstrate that the systemic component of recovery risk (driven by macroeconomic conditions) exerts greater influence on loss estimation and fair risk pricing than its standalone component.

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