A loss curve is a graph that shows the expected losses on a securitisation as a function of the number of defaults. The loss curve is typically used to assess the risk of a securitisation and to determine the appropriate level of credit enhancement.
The loss curve is calculated by taking the expected losses on each underlying asset and then aggregating those losses. The expected losses on each underlying asset are calculated based on the probability of default and the loss given default.
The loss curve is typically presented as a graph with the number of defaults on the x-axis and the expected losses on the y-axis. The graph is typically divided into two sections: the left section shows the expected losses on the senior tranches and the right section shows the expected losses on the subordinated tranches.
The applications of loss curves in securitisation include:
- To assess the risk of a securitisation: The loss curve can be used to assess the risk of a securitisation by showing the expected losses as a function of the number of defaults. This can help investors to determine whether the securitisation is a suitable investment for their risk appetite.
- To determine the appropriate level of credit enhancement: The loss curve can be used to determine the appropriate level of credit enhancement for a securitisation. Credit enhancement is a form of insurance that protects investors against losses. The higher the loss curve, the higher the level of credit enhancement that is required.
- To price the securities: The loss curve can be used to price the securities issued in a securitisation. The higher the loss curve, the lower the price of the securities.
Loss curves can be a valuable tool for securitisation transactions. They can help to assess the risk of a securitisation, determine the appropriate level of credit enhancement, and price the securities.
Here are some of the benefits of using loss curves in securitisation transactions:
- Increased transparency: The loss curve provides investors with a transparent view of the risk of the securitisation. This can help investors to make informed investment decisions.
- Improved risk management: The loss curve can be used to help manage the risk of a securitisation. By understanding the expected losses, investors can take steps to mitigate those losses.
- Increased liquidity: The loss curve can help to increase the liquidity of a securitisation. By providing investors with a better understanding of the risk, the loss curve can make the securitisation more attractive to investors.
Overall, loss curves can be a valuable tool for securitisation transactions. They can help to improve transparency, risk management, and liquidity.