A Framework for LGD Validation of Retail Portfolios

Abstract

Modeling and estimating the loss given default (LGD) is necessary for banks which apply for the Internal-Ratings Based Approach for retail portfolios. To validate LGD estimations there are only very few approaches discussed in the literature. In this paper, two models for validating relative LGDs and absolute losses are developed. The validation of relative LGDs is important for risk-adjusted credit pricing and interest rate calculations. The validation of absolute losses is important to meet the capital requirements of Basel II. Both models are tested with real data of a bank. Estimations are tested for robustness with in-sample and out-of-sample tests.