Advanced Search
MyIDEAS: Login

Estimating implied recovery rates from the term structure of CDS spreads

Contents:

Author Info

  • Marcin Jaskowski

    (Erasmus School of Economics, Erasmus University Rotterdam)

  • Michael McAleer

    (Econometric Institute Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute The Netherlands and Institute of Economic Research Kyoto University Japan and Department of Quantitative Economics Complutense University of Madrid Spain)

Abstract

Credit risk models should reect the observation that the relevant value of collateral is generally not the average value of the asset over all possible states of nature. In most cases, the relevant value of collateral for the lender is its secondary market value in bad states of nature, where marginal utilities are high. Although the negative correlation between recovery rates and default probabilities is well documented, the majority of pricing models does not allow for correlation between the two. In this paper, we propose a relatively parsimonious reduced-form continuous time model that estimates expected recovery rates and default probabilities from the term structure of CDS spreads. The parameters of the model and latent factors driving recovery risk and default risk are estimated using a Bayesian MCMC algorithm. We nd that the Bayesian deviance information criterion (DIC) favors the model with stochastic recovery over constant recovery. We also observe that for companies with a good rating, implied constant recovery rates do not dier much from stochastic recovery. However, if a company is very risky, then forward stochastic recovery rates are signicantly lower at longer maturities.

Download Info

If 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.
File URL: http://www.kier.kyoto-u.ac.jp/DP/DP836.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 836.

as in new window
Length: 31pages
Date of creation: Dec 2012
Date of revision:
Handle: RePEc:kyo:wpaper:836

Contact details of provider:
Postal: Yoshida-Honmachi, Sakyo-ku, Kyoto 606-8501
Phone: +81-75-753-7102
Fax: +81-75-753-7193
Email:
Web page: http://www.kier.kyoto-u.ac.jp/eng/index.html
More information through EDIRC

Related research

Keywords: Constant recovery; stochastic recovery; implied recovery rate; term structure; CDS spreads.;

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Max Bruche & Carlos González Aguado, 2006. "Recovery Rates, Default Probabilities And The Credit Cycle," Working Papers wp2006_0612, CEMFI.
  2. John Y. Campbell & Stefano Giglio & Parag Pathak, 2011. "Forced Sales and House Prices," American Economic Review, American Economic Association, vol. 101(5), pages 2108-31, August.
  3. Acharya, Viral V. & Bharath, Sreedhar T. & Srinivasan, Anand, 2007. "Does industry-wide distress affect defaulted firms? Evidence from creditor recoveries," Journal of Financial Economics, Elsevier, vol. 85(3), pages 787-821, September.
  4. Efraim Benmelech & Nittai K. Bergman, 2011. "Bankruptcy and the Collateral Channel," Journal of Finance, American Finance Association, vol. 66(2), pages 337-378, 04.
  5. David J. Spiegelhalter & Nicola G. Best & Bradley P. Carlin & Angelika van der Linde, 2002. "Bayesian measures of model complexity and fit," Journal of the Royal Statistical Society Series B, Royal Statistical Society, vol. 64(4), pages 583-639.
  6. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  7. 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, vol. 78(6), pages 2203-2228, November.
  8. Jun Pan & Kenneth J. Singleton, 2008. "Default and Recovery Implicit in the Term Structure of Sovereign "CDS" Spreads," Journal of Finance, American Finance Association, vol. 63(5), pages 2345-2384, October.
  9. Das, Sanjiv R. & Hanouna, Paul, 2009. "Implied recovery," Journal of Economic Dynamics and Control, Elsevier, vol. 33(11), pages 1837-1857, November.
  10. Schneider, Paul & Sögner, Leopold & Veža, Tanja, 2011. "The Economic Role of Jumps and Recovery Rates in the Market for Corporate Default Risk," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(06), pages 1517-1547, January.
Full references (including those not matched with items on IDEAS)

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:kyo:wpaper:836. See general 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: (Ryo Okui).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.