Measuring Final Loss Severity of Defaulted RMBS

Abstract

Investigation of three approaches to estimating final loss, given default, for residential mortgage-based securities recommends a blended approach that combines both static factors such as tranche size and dynamic factors such as cumulative loss as a share of principal balance reduced to date in a model to predict the remaining losses on non-matured defaulted securities. There is a survival bias in the current LGD data sample, in that defaulters that have not matured would sustain significantly smaller ultimate losses than defaulters that have matured. On average, a defaulted RMBS security is estimated to lose about 51% of its default date balance or 34% of its original balance. Empirical findings like this are essential to the calculation of expected loss rates and risk-based capital for structured products.