Understanding the Role of Recovery in Default Risk Models: Empirical Comparisons and Implied Recovery Rates

Bakshi, Gurdip; Madan, Dilip B.; Zhang, Frank X.

doi:10.2139/ssrn.285940

Cited by 85 publications

(85 citation statements)

References 37 publications

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“…Pan and Singleton (2008) illustrate that long-maturity CDS are essential for identification since the impact of changes in the recovery rate on short-maturity CDS is low. Bakshi, Madan, and Zhang (2006b) report that, while corporate bond data support the recovery of Treasury formulation, the CDS market prefers recovery of face value, which in comparison also yields less volatile expected recovery rates. We therefore employ the recovery of face value formulation.…”

Section: Model Specificationmentioning

confidence: 99%

The Economic Role of Jumps and Recovery Rates in the Market for Corporate Default Risk

Schneider¹,

Sögner²,

Veža³

2010

J. Financ. Quant. Anal.

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A previous version of this paper was circulated as "Jumps and Recovery Rates Inferred from Corporate CDS Premia". We are thankful to FIRM@WU for access to their high-performance computing resources as well as friendly support, and to Dow Jones for providing us with complete ICB sector information. AbstractUsing an extensive cross-section of US corporate CDS this paper offers an economic understanding of implied loss given default (LGD) and jumps in default risk. We formulate and underpin empirical stylized facts about CDS spreads, which are then reproduced in our affine intensity-based jump-diffusion model. Implied LGD is well identified, with obligors possessing substantial tangible assets expected to recover more. Sudden increases in the default risk of investment-grade obligors are higher relative to speculative grade. The probability of structural migration to default is low for investment-grade and heavily regulated obligors because investors fear distress rather through rare but devastating events.

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Section: Model Specificationmentioning

confidence: 99%

The Economic Role of Jumps and Recovery Rates in the Market for Corporate Default Risk

Schneider¹,

Sögner²,

Veža³

2010

J. Financ. Quant. Anal.

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“…Similar to Bakshi, Madan, Zhang [5], Janosi, Jarrow and Yildirim [14], and Das and Hanouna [10]) we formulate and estimate a new recovery rate process useful for pricing distressed debt. Our model is shown to provide a good …t to the market prices of distressed debt.…”

Section: Introductionmentioning

confidence: 99%

“…If the industry recovery rates are biased or misspeci…ed, 1 then these results can not be accepted as valid. Lastly, there are a few papers that use pre-default risky debt or credit default swap (CDS) pricing models to infer the embedded recovery rate (see Bakshi, Madan, Zhang [5], Janosi, Jarrow and Yildirim [14], and Das and Hanouna [10]). These papers are not dependent on the validity of the industry recovery rate estimates.…”

Section: Introductionmentioning

confidence: 99%

Distressed debt prices and recovery rate estimation

2008

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This paper has two purposes. First, it uses distressed debt prices to estimate recovery rates at default. In this regard, estimates are obtained for three recovery rate models: recovery of face value, recovery of Treasury, and recovery of market value. We show that identifying the "economic" default date, as distinct from the recorded default date, is crucial to obtaining unbiased estimates. The economic default date is de…ned to be that date when the market prices the …rm's debt as if it has defaulted. An implication is that the standard industry practice of using 30-day post default prices to compute recovery rate yields biased estimates. Second, we construct and estimate a distressed debt pricing model. We use this model to implicitly estimate the parameters of the embedded recovery rate process and to price distressed debt. Our distressed debt pricing model …ts market prices well, with an average pricing error of less than one basis point.

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“…Our study is related to Driessen (2005) and Bakshi et al (2006) who are also interested in estimating default risk but they use corporate bond data. Driessen (2005) adopts a maximum likelihood method with Kalman lter to infer risk premium associated with default jump risk from US corporate bond prices.…”

Section: Introductionmentioning

confidence: 99%

“…Driessen (2005) adopts a maximum likelihood method with Kalman lter to infer risk premium associated with default jump risk from US corporate bond prices. Meanwhile, Bakshi et al (2006) di erentiate the roles of recovery rates and default probabilities in determining defaultable bond prices. Di erent from their methodology and data, we propose a nonlinear lter to perform a joint estimation of the latent default intensity and CIR parameters from CDS spreads.…”

Section: Introductionmentioning

confidence: 99%

Recovering default risk from CDS spreads with a nonlinear filter

Guarin¹,

Liu²,

Ng³

2014

Journal of Economic Dynamics and Control

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We propose a nonlinear lter to estimate the time-varying instantaneous default risk from the term structure of credit default swap (CDS) spreads. Based on the numerical solution of the Fokker-Planck equation (FPE) using a meshfree interpolation method, the lter performs a joint estimation of default intensities and CIR model parameters. As the FPE can account for nonlinear functions and nonGaussian errors, the proposed framework provides more exibility and accuracy.We test the nonlinear lter on simulated CDS spreads and apply it to daily CDS spreads of the Dow Jones Industrial Average component companies from 2005 to 2010 with supportive results.

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Understanding the Role of Recovery in Default Risk Models: Empirical Comparisons and Implied Recovery Rates

Cited by 85 publications

References 37 publications

The Economic Role of Jumps and Recovery Rates in the Market for Corporate Default Risk

The Economic Role of Jumps and Recovery Rates in the Market for Corporate Default Risk

Distressed debt prices and recovery rate estimation

Recovering default risk from CDS spreads with a nonlinear filter

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