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Unexpected Loss

  • UL is the estimated volatility of the potential loss in value of the asset around its EL
  • UL is the standard deviation of the unconditional value of the asset at the time horizon
  • UL = s.d. of expected asset value
  • UL = AE*√[EDF* σ2LGD +LGD2* σ2EDF ]
    • Underlying assumption that EDF is independent of LGD.  In case it is not so then correlation between LGD and EDF terms will come into picture. Though it has been found that they will affect the result only slightly
  • What if all the variance were zero?

Visualizing: Unexpected Loss


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