Pricing the Risk of Recovery in Default with APR Violation
AbstractThis paper proposes a simple approach to infer the risk neutral density of recovery rates implied by the prices of the debt securities of a firm. The proposed approach is independent of modeling default arrival rates and allows for the violation of absolute priority rule (APR). The paper demonstrates that a new statistic, the adjusted relative spread, captures risk neutralrecovery information in debt prices. Interest rates and firm tangible assets are shown to be significant determinants of the price of recovery. An application illustrates the pricing of credit derivatives written on the realized recovery rate.
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Bibliographic InfoPaper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 02-21.
Date of creation: Aug 2001
Date of revision:
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Recovery rates; APR violation; Risky debt pricing; Credit risk; Credit deriva-tives;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2002-05-03 (All new papers)
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