Loss Given Default (LGD) is a crucial metric in the world of finance, particularly in credit risk assessment. It represents the potential loss a lender or investor may incur in the event of a borrower’s default. In this article, we’ll delve into the definition of LGD, explore two common methods of calculating it, and provide a practical example to illustrate its application.
Loss Given Default (LGD) is a measure that quantifies the severity of losses in the event of a borrower’s default. It is expressed as a percentage of the exposure at default (EAD), which is the total amount at risk when a borrower fails to meet their financial obligations. LGD takes into account recoveries from collateral or other sources and reflects the residual loss after such recoveries.
Loss Given Default is a critical metric for financial institutions, guiding their risk management strategies. Understanding how to calculate LGD using both direct and indirect methods provides valuable insights into potential losses in the event of borrower default. As the financial landscape evolves, incorporating robust LGD calculations into risk models becomes increasingly important for making informed lending and investment decisions.
