Implied Market Loss Given Default in the Czech Republic: Structural-Model Approach

Abstract

This paper focuses on the key credit risk parameter – Loss Given Default (LGD). We describe its general properties and determinants with respect to seniority of debt, characteristics of debtors and macroeconomic conditions. Furthermore, we illustrate how the LGD can be extracted from market observable information with help of the adjusted Mertonian structural approach. We present a derivation of the formula for the expected LGD and show its sensitivity with respect to other structural company parameters. Finally, we estimate the 5-year expected LGDs for companies listed on the Prague Stock Exchange and find that the average LGD for this analyzed sample is in the range of 20–45 %. To the authors’ knowledge, these are the first implied market estimates of LGD in the Czech Republic.loss given default, credit risk, structural models