Default Probability, Loss Given Default, and Credit Portfolio Models

Abstract

We have seen that counterparty credit risk calculations have, mainly, three components: first we need to estimate what the probability is of a given counterparty defaulting This number is usually referred to as the “PD” of the counterparty Then, we need to estimate how much we can be owed if a given counterparty defaults, the Exposure at Default (EaD) We have seen in previous chapters that there are different metrics for this, the most popular being the Expected Positive Exposure and the Potential Future Exposure.¹ Finally, we want to have a view as to how much of the whole amount that we are owed in a default we will actually be lost This is typically called the Loss Given Default (LGD), which is expressed as a percentage of the total amount owed in a default.