The Selection of the Discount Rate in Estimating Loss Given Default

In light of the management and regulatory advances regarding the Loss Given Default, this paper takes on the topic of choosing the proper rate for the estimate of the current value of recoveries. By means of a review of the available literature on LGD, the solutions adopted in the selection of the discount rate are analyzed and compared, in particular with reference to how they vary: contractual rate, risk-free rate and the rate determined using single-factor approaches. In order to understand the influence of market constraints from both the static and dynamic standpoints the paper studies in depth the purposes and the methodologies for the selection of the discount rate in accounting and prudential standards.
Considering the limitations of the approaches found in the literature, whether academic or operational, to the measurement of the discount rate relative to the estimate of the economic loss after insolvency has been demonstrated, the paper proposes a multi-factor model based on systemic and specific factors that, in light of the aggregate empirical evidence, can serve as explanations for the variability of the LGD.