An empirical study of the returns on defaulted debt
AbstractThis study empirically analyses the historical performance of defaulted debt from Moody's Ultimate Recovery Database (1987--2010). Motivated by a stylized structural model of credit risk with systematic recovery risk, we argue and find evidence that returns on defaulted debt co-vary with determinants of the market risk premium, firm specific and structural factors. Defaulted debt returns in our sample are observed to be increasing in collateral quality or debt cushion of the issue. Returns are also increasing for issuers having superior ratings at origination, more leverage at default, higher cumulative abnormal returns on equity prior to default, or greater market implied loss severity at default. Considering systematic factors, returns on defaulted debt are positively related to equity market indices and industry default rates. On the other hand, defaulted debt returns decrease with short-term interest rates. In a rolling out-of-time and out-of-sample re-sampling experiment we show that our leading model exhibits superior performance. We also document the economic significance of these results through excess abnormal returns, implementing a hypothetical trading strategy, of around 5%--6% (2%--3%) assuming zero (1 bp per month) round-trip transaction costs. These results are of practical relevance to investors and risk managers in this segment of the fixed income market.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by Taylor & Francis Journals in its journal Applied Financial Economics.
Volume (Year): 22 (2012)
Issue (Month): 7 (April)
Contact details of provider:
Web page: http://www.tandfonline.com/RAFE20
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Michael McNulty).
If references are entirely missing, you can add them using this form.