A qualitative and quantitative analysis of the risk parameter LGD based on the Basel II Framework

Abstract: Title: A qualitative and quantitative analysis of the risk parameter LGD based on the Basel II Framework Seminar date: 27 January 2007 Course: Financial Economy, Master Thesis, 10 poäng (15 ECTS) Author: Helén Dybing Advisor: Hans Byström Key words: LGD, LTV, Risk, Basel II, Estimation model Purpose: The purpose of this thesis is to get a deeper understanding of the risk parameter LGD and try to identify which variables drive it and how. Further the purpose of analysing the LGD/LTV relationship is to see how the risk parameter interacts with other parameters that are included in risk management. Everything in this thesis has a starting point in the Basel II Framework which has the purpose to see how well the Basel II guidelines and regulations work with LGD. Methodology: The thesis is divided into two separate analyses, a qualitative and a quantitative. The LGD values that are received from the statistical model are used as the historical data upon which the qualitative verbal LGD estimation model is based. Conclusion: The quantitative analysis showed a positive but non- linear relationship between the risk parameter LGD and LTV. When looking closer at the variables included in both the LGD model and the LTV model, the analysis showed that all variables that where included, in some way had an affect. To create variations, both in LGD and the LGD/LTV relationship, the changes in the variables had to be unrealistically large. The Basel II Framework gives the banks several choices when setting up bank internal models. My verbal estimation model set up in this thesis was done accordingly to the workout LGD estimation model which could work in reality if the correct statistical data was inserted.