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Empirical Evidence for the Structural Recovery Model

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  • Alexander Becker
  • Alexander F. R. Koivusalo
  • Rudi Sch\"afer
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    Abstract

    While defaults are rare events, losses can be substantial even for credit portfolios with a large number of contracts. Therefore, not only a good evaluation of the probability of default is crucial, but also the severity of losses needs to be estimated. The recovery rate is often modeled independently with regard to the default probability, whereas the Merton model yields a functional dependence of both variables. We use Moody's Default and Recovery Database in order to investigate the relationship of default probability and recovery rate for senior secured bonds. The assumptions in the Merton model do not seem justified by the empirical situation. Yet the empirical dependence of default probability and recovery rate is well described by the functional dependence found in the Merton model.

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    File URL: http://arxiv.org/pdf/1203.3188
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1203.3188.

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    Date of creation: Mar 2012
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    Handle: RePEc:arx:papers:1203.3188

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    1. Shumway, Tyler, 2001. "Forecasting Bankruptcy More Accurately: A Simple Hazard Model," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 74(1), pages 101-24, January.
    2. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
    3. Edward Altman & Andrea Resti & Andrea Sironi, 2004. "Default Recovery Rates in Credit Risk Modelling: A Review of the Literature and Empirical Evidence," Economic Notes, Banca Monte dei Paschi di Siena SpA, Banca Monte dei Paschi di Siena SpA, vol. 33(2), pages 183-208, 07.
    4. Jon Frye, 2000. "Depressing recoveries," Emerging Issues, Federal Reserve Bank of Chicago, Federal Reserve Bank of Chicago, issue Oct.
    5. Rudi Sch\"afer & Alexander F. R. Koivusalo, 2011. "Dependence of defaults and recoveries in structural credit risk models," Papers 1102.3150, arXiv.org, revised Mar 2011.
    6. Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
    7. Sudheer Chava & Catalina Stefanescu & Stuart Turnbull, 2011. "Modeling the Loss Distribution," Management Science, INFORMS, INFORMS, vol. 57(7), pages 1267-1287, July.
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    Cited by:
    1. Adrian Cantemir CALIN & Oana Cristina POPOVICI, 2014. "Modeling Credit Risk Through Credit Scoring," Internal Auditing and Risk Management, Athenaeum University of Bucharest, Athenaeum University of Bucharest, vol. 2(34), pages 99-109, June.

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