A volatility-based single parameter Loss Given Default model

Abstract

This paper proposes an alternative recovery model (ie Loss Given Default (LGD) Mapping Function) that links LGD to default rate through a single asset volatility parameter. The model is closed-form and easy to calibrate. It may be applied to wholesale credit risk management, such as LGD forecasting, stress testing and integration into the Basel advanced internal rating-based (AIRB) framework. The model may also potentially be applied to market risk management, such as derivation of market-based LGD for the purpose of regulatory credit valuation adjustment (CVA) under Basel advanced CVA capital framework.