Lifetime Expected Credit Losses
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Definition
Lifetime Expected Credit Losses are the expected credit losses that result from all possible default events over the expected life of a financial instrument.
Formula
Conceptually the definition is captured in the following mathematical expression
- Where t is the reporting date
- T is the Expected Life of the instrument
- i denotes possible times of default / loss (normally associated with instrument cashflows)
- di is the random (unknown) event of default at time i
- LGD denotes Loss Given Default
- EAD denotes Exposure at Default
- D(t,i) denotes the discount rate at time t (based on the Effective Interest Rate, for the different cashflow maturities i
- Ft denotes the subjective but Forward-Looking Information set used formulate the estimate at time t
- P denotes the subjective assignment of default probabilities to the events di
This formula captures the essence of the definition. In practice evaluation of LECL may utilize a variety of simplified / approximate forms. A common simplification is the use of the concept of Lifetime PD