Estimating LGD Correlation

The paper proposes a new method to estimate correlation of account level Basle II Loss Given Default (LGD). The correlation determines the probability distribution of portfolio level LGD in the context of a copula model which is used to stress the LGD parameter as well as to estimate the LGD discount rate and other parameters. Given historical LGD observations we apply the maximum likelihood method to estimate the best correlation parameter. The method is applied and analyzed on a real large data set of unsecured retail account level LGDs and the corresponding monthly series of the average LGDs. The correlation estimate comes relatively close to the PD regulatory correlation. It is also tested for stability using the bootstrapping method and used in an efficient formula to estimate ex ante one-year stressed LGD, i.e. one-year LGD quantiles on any reasonable probability level

An international forensic perspective of the determinants of bank CDS spreads

In this paper, we provide a forensic perspective of the determinants of banks' CDS spreads. Using data for 118 banks of 30 countries over the period 2004-2011, we find that banks' default risk typically reflects: (i) the quality of the banks’ balance sheet; (ii) liquidity of banks’ assets; (iii) how profitable banks’ operations are; (iv) the banks’ leverage ratios; and (v) how stringent/lenient regulatory capital ratios are. Considering a series of indicators of the financial structure of the banking system, our results reveal that: (i) higher concentration of the banking sector, stronger presence of foreign banks and a deterioration of the health of the banking sector lead to higher banks' CDS spreads; and (ii) the availability of alternative means of finance does not significantly influence banks' default risk. We also show that periods of high inflation, low GDP growth and stock market crashes are prone to an intensification of tensions in the banking system, but financial reforms (especially, in the field of banking supervision and privatizations) can mitigate them. Moreover, the timing, the duration and the composition of fiscal consolidation programs have a significant impact on banks' CDS spreads, and, in particular, expenditure-driven consolidation episodes are associated with a rise in banks' default risk. Finally, we highlight that although the financial crisis of 2008-2009 was a global event, higher quality of economic and legal institutions (and, therefore, in the regulatory framework) could have dampened the rise in bank' CDS spreads