Unexpected Loss

[[email protected]]

Hi! Good day!

1.Unexpected loss is one standard deviation or a multiple standard deviation of EL .
2.UL formula is UL = SQRT[(EDF)(variance of LGD)+(LGD^2)(variance of EDF)

I could not reconcile these 2 concepts. Where is the standard deviation of EL captured in the UL formula? Your guidance, please.

Cheers
learning

 

[David Harper CFA FRM]

Hello to you chunleeng!

1. UL (under the Ong definition) is one standard deviation of *asset value* about the EL; i.e., the expected future value of the asset is (1-EL)*asset value(0). So, the EL is the mean of the distribution and the UL is volatility of the asset itself

2. such that potential loss in asset value drives the UL, which is a primarily a function of EDF and LGD: they give the asset distribution its "shape" (The EL is linear). The actual derivation (IMO) is quite technical, but can be found for the brave in Ong' s appendix.

David