Discount Rate for Workout Recovery: An Empirical Study

Unexpected Recovery Risk and LGD Discount Rate Determination

“…Given the time-specific risk free rate r f (corresponding to the average cash flow duration) we can then calculate the risk premium RP = r -r f that should be used for general discount rate definition (defined as the actual risk free rate plus the risk premium) on defaulted receivables of the LGD class. This approach has been taken for example by Brady et al (2006) in an empirical study based on observed market prices and subsequent recoveries of bonds and banking loans. The study has identified some drivers of the discount rates and shown significant differences for various classes of defaulted assets.…”

Unexpected Recovery Risk and LGD Discount Rate Determination

“…Given the time-specific risk free rate r f (corresponding to the 66 average cash flow duration) we can then calculate the risk premium RP = r -r f that should be used for general discount rate definition (defined as the actual risk free rate plus the risk premium) on defaulted receivables of the LGD class. This approach has been taken for example by Brady et al (2006) in an empirical study based on observed market prices and subsequent recoveries of bonds and banking loans. The study has identified some drivers of the discount rates and shown significant differences for various classes of defaulted assets.…”

“…The empirical studies are however in most cases based on market data on defaulted bonds where the recovery values are observed as market values of the bonds shortly after default. The discount rates implicitly used in such quotations are studied in Brady et al (2006) and to the authors knowledge there is no other published study dealing with the discount rates from theoretical or empirical point view.…”

An Empirical Study of the Returns on Defaulted Debt and the Discount Rate for Loss-Given-Default

“…The methodological note discusses the quantitative issues and methods that are associated with estimating recovery distributions and their associated market risk premia. The author argues that the approach of Brady et al (2006), which suggests that an empirically derived rate of return measures on defaulted debt, may be severely biased.…”

“…We then compare this to various alternatives. First, as proposed by Brady et al (2006), an approach that involves solving for a discount rate within a homogenous segment that has the highest likelihood of being the prevalent rate of return in the market at the time of default ("most likely discount rate" -MLDR). Second, we examine the technique of Machlachlan (2003), who develops a risk premium over the risk-free rate that is derived from a structural credit or a market based model.…”