European Financial and Accounting Journal 2009, 4(1):61-84 | DOI: 10.18267/j.efaj.63

Unexpected Recovery Risk and LGD Discount Rate Determination

Jiří Witzany
RNDr. Jiří Witzany, Ph.D. - assistant professor; Department of Banking and Insurance, Faculty of Finance and Accounting, University of Economics, Prague, W. Churchill Sq. 4, 130 67 Prague 3, Czech Republic; <witzanyj@vse.cz>.

The Basle II parameter called Loss Given Default (LGD) aims to estimate the expected losses on not yet defaulted accounts in the case of default. Banks firstly need to collect historical recovery data, discount the recovery income and cost cash flow to the time of default, and calculate historical recovery rates and LGDs. One of the puzzling tasks is to determine an appropriate discount rate which is very vaguely characterized by the regulation. This paper proposes a market consistent methodology for the LGD discount rate determination based on estimation of the systematic, i.e. undiversifiable, recovery risk and a cost of the risk.

Keywords: Credit risk, Discount rate, Loss given default, Recovery rate, Regulatory capital
JEL classification: C14, G21, G28

Published: March 1, 2009  Show citation

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Witzany, J. (2009). Unexpected Recovery Risk and LGD Discount Rate Determination. European Financial and Accounting Journal, 4(1), 61-84. doi: 10.18267/j.efaj.63
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