Regulatory Downturn LGD Fails, Risk Underestimation Puts Banks at Risk.
The article examines the adequacy of the current regulatory downturn LGD in estimating risk for large banks. By analyzing data from over 50 international banks, the researchers found that the current method falls short of the required survival probability of 99.9%. They developed a new approach using latent variables that outperforms the existing method and improves accuracy. This new method can be applied to both market-based and workout LGD models.