Keywords: Recovery rate, default, credit risk model
Abstract: A frictionless, structural view of default has the unrealistic implication
that recovery rates on bonds, measured at default, should be close to 100
percent. This suggests that standard "frictions" such as default delays,
corporate-valuation jumps, and bankruptcy costs may be important drivers
of recovery rates. A structural view also suggests the existence of
nonlinearities in the empirical relationship between recovery rates and
their determinants. We explore these implications empirically and find
direct evidence of jumps, and also evidence of the predicted nonlinearities.
In particular, recovery rates increase as economic conditions improve from
low levels, but decrease as economic conditions become robust. This
suggests that improving economic conditions tend to boost firm values,
but firms may tend to default during particularly robust times only when
they have experienced large, negative shocks.
Full paper (266 KB PDF)
Home | FEDS | List of 2005 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: February 16, 2005