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Restructuring Risk in Credit Default Swaps: An Empirical Analysis

  • Antje Berndt
  • Robert Jarrow
  • ChoongOh Kang

This paper estimates the price for restructuring risk in the U.S. 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% to 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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Paper provided by Carnegie Mellon University, Tepper School of Business in its series GSIA Working Papers with number 2006-E30.

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Date of creation: Dec 2006
Date of revision:
Handle: RePEc:cmu:gsiawp:1142637814
Contact details of provider: Postal: Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213-3890
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  1. Edwin J. Elton, 2001. "Explaining the Rate Spread on Corporate Bonds," Journal of Finance, American Finance Association, vol. 56(1), pages 247-277, 02.
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  14. Maria Vassalou & Yuhang Xing, 2004. "Default Risk in Equity Returns," Journal of Finance, American Finance Association, vol. 59(2), pages 831-868, 04.
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  17. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
  18. Kose John, 1993. "Managing Financial Distress and Valuing Distressed Securities: A Survey and a Research Agenda," Financial Management, Financial Management Association, vol. 22(3), Fall.
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