What's new

Impact LGD from period 1 to period 2

Thread starter #1

I have a question. The IRB approach to calculate RWA is RWA=12,5*K*EAD. The formula to calculate K is K = a * LGD * f(PD,conf.interval) * f(PD,maturity).

I want to calculate the effect on RWA from changes in EAD, LGD and PD. Let's say I have period 1 and period 2. My plan is to first calculate total RWA in period 1 and then total RWA in period 2. RWA period 2 minus RWA period 1 is the total RWA change. I now want to determine how much of this change in RWA comes from changes in EAD, LGD and PD separately. For example, if I want to determine how much of the total RWA change comes from a change in LGD, can I then just keep all values from period 1 in the calculation, and just have the LGD from period 2, in order to see how much the change in LGD has impacted RWA?

Many thanks!

David Harper CFA FRM

David Harper CFA FRM
Staff member
Hi @KlarinettSax Here is the IRB sheet from our Basel workbook https://www.dropbox.com/s/12goncaxipw9ebo/1128-basel-irb.xlsx?dl=0
The exposure and LGD are linear, so they are easy (or easier). The challenge is that PD enters the Merton/ASRF function in a very non-trivial way (formula is in the XLS). It is interesting to me that you want to solve for, essentially, marginal RWA (ΔRWA/ΔPD), but I do not recall reading specific examples of this. I'd probably go the simulation route. I hope the XLS is helpful, good luck!