Work detail

Reduced-form approach to LGD modeling

Author: Mgr. Ivana Hlavatá
Year: 2011 - summer
Leaders: PhDr. Jakub Seidler Ph.D.
Consultants:
Work type: Finance, Financial Markets and Banking
Masters
Language: English
Pages: 110
Awards and prizes:
Link:
Abstract: The master thesis deals with the advanced methods for estimating credit risk parameters from
market prices: probability of default (PD) and loss given default (LGD). Precise evaluation of
these parameters is important not only for banks to calculate their regulatory capital but also for
investors to price risky bonds and credit derivatives.
We provide forward looking reduced-form analytical method for calculation of PD and
LGD of corporate defaultable bonds based on their quoted market prices, prices of equivalent
risk-free bonds and quoted credit default swap spreads of the issuer of these bonds. This is
reversed to most of the studies on credit risk modeling, as aim is not to price instruments based
on estimated credit risk parameters, but to calculate these parameters based on the available
market prices. Furthermore, compared to other studies, the LGD parameter is assumed to be
endogenous and we provide the method for its simultaneous calculation with the probability of
default. Finally, using developed methods, we estimate implied PD and LGD for five European
banks assuming that the risk is priced correctly by other investors and the markets are efficient.
Downloadable: Diploma Thesis of Hlavatá

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