Empirically,recessions witness a rise in default rates.Which of the following scenarios also accompanies the rise in default rates?
A)Recovery rates rise.
B)Loss given default (LGD)falls
C)LGD rises
D)LGD becomes highly volatile.

Question

Quizplus · Accepted Answer

LGD (Loss given default) typically rises during recessions along with default rates, as economic conditions are more unfavorable and it becomes more difficult for borrowers to recover from a default. This may be due to the distressed sale of collateral or the inability of the borrower to repay the loan in full. Therefore, option C is the most likely scenario that accompanies the rise in default rates during recessions. Options A and D are unlikely because recovery rates and LGD volatility tend to decline during recessions, while option B is incorrect because LGD (the amount lost if a borrower defaults) would typically increase in the event of more defaults.

Empirically,recessions Witness a Rise in Default Rates