LGD credit risk model: estimation of capital with parameter uncertainty using MCMC

Details LGD credit risk model: estimation of capital with parameter uncertainty using MCMC LGD credit risk model: estimation of capital with parameter uncertainty using MCMC

2010-11-12

arxiv.org/abs/1011.2827v3

Economy

Quantitative Finance

Risk Management

29 pages including 5 tables and 5 figures

Scientific paper

This paper investigates the impact of parameter uncertainty on capital estimate in the well-known extended Loss Given Default (LGD) model with systematic dependence between default and recovery. We demonstrate how the uncertainty can be quantified using the full posterior distribution of model parameters obtained from Bayesian inference via Markov chain Monte Carlo (MCMC). Results show that the parameter uncertainty and its impact on capital can be very significant. We have also quantified the effect of diversification for a finite number of borrowers in comparison with the infinitely granular portfolio.

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