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Default recovery rates and aggregate fluctuations

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  • Candian, Giacomo
  • Dmitriev, Mikhail

Abstract

Default recovery rates in the US are highly volatile and pro-cyclical. We show that state-of-the-art models with a Bernanke-Gertler-Gilchrist financial accelerator mechanism imply that recovery rates are flat over the cycle. We propose a model where financially-constrained entrepreneurs face an idiosyncratic cost of redeploying liquidated capital. The resulting endogenous liquidation costs magnify the effect of the financial accelerator. We fit the model to US data and find that it explains a substantial amount of variation in recovery rates, including their sharp contraction at the onset of the Great Recession. Our mechanism delivers a more flexible relationship between credit spreads and macroeconomic variables and leads to novel policy implications about the effectiveness of subsidies for liquidated assets.

Suggested Citation

  • Candian, Giacomo & Dmitriev, Mikhail, 2020. "Default recovery rates and aggregate fluctuations," Journal of Economic Dynamics and Control, Elsevier, vol. 121(C).
    • Handle: RePEc:eee:dyncon:v:121:y:2020:i:c:s0165188920301792
    DOI: 10.1016/j.jedc.2020.104011
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    Cited by:

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    3. Aicha Kharazi & Francesco Ravazzolo, 2023. "Regulatory Collateral Requirements and Delinquency Rate in a Two-Agent New Keynesian Model," Working Paper series 23-03, Rimini Centre for Economic Analysis.

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    More about this item

    Keywords

    Financial accelerator; Financial frictions; Recovery rates; Liquidation costs;
    All these keywords.

    JEL classification:

    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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