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Restructuring risk in credit default swaps: An empirical analysis

  • Berndt, Antje
  • Jarrow, Robert A.
  • Kang, ChoongOh

This paper estimates the price for restructuring risk in the US corporate bond market during 1999-2005. Comparing quotes from default swap (CDS) contracts with a restructuring event and without, we find that the average premium for restructuring risk represents 6%-8% of the swap rate without restructuring. We show that the restructuring premium depends on firm-specific balance-sheet and macroeconomic variables. And, when default swap rates without a restructuring event increase, the increase in restructuring premia is higher for low-credit-quality firms than for high-credit-quality firms. We propose a reduced-form arbitrage-free model for pricing default swaps that explicitly incorporates the distinction between restructuring and default events. A case study illustrating the model's implementation is provided.

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Article provided by Elsevier in its journal Stochastic Processes and their Applications.

Volume (Year): 117 (2007)
Issue (Month): 11 (November)
Pages: 1724-1749

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Handle: RePEc:eee:spapps:v:117:y:2007:i:11:p:1724-1749
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  1. Darrell Duffie & Leandro Siata & Ke Wang, 2006. "Multi-Period Corporate Default Prediction With Stochastic Covariates," NBER Working Papers 11962, National Bureau of Economic Research, Inc.
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