LGD Risk denotes the risk that following a Default Event, contracts of the defaulting entity cannot be honoured in full, thereby leading to financial loss to the lender or other counterparty. The precise loss fraction is now known. LGD risk is synonymous to Recovery Risk and many Loss Given Default models (as listed in the Catalog of Loss Given Default Models) explicitly introduce and aim to model this uncertainty.
- Timing Risk: The duration over which a final recovery will be achieved
- Recovery Amount Risk: The cumulative amounts that will be recovered
Issues and Challenges
- Large Corporates and sovereigns are diversified entities with sufficient financial means, this imply that default events are actually fairly rare. This paucity of data makes the prediction of possible recoveries in case of default rather challenging. This is denoted as the Low Default Portfolios problem