Home About Latest Browse RSS Advanced Search

Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Understanding the role of recovery in default risk models: empirical comparisons and implied recovery rates
Gurdip Bakshi
Dilip B. Madan
Frank X. Zhang
Abstract

This article presents a framework for modeling defaultable debt under alternative recovery conventions (for a wide class of processes describing recovery rates and default probability). These debt models have the ability to differentiate the impact of recovery rates and default probability, and can be utilized to invert the market expectation of recovery rates implicit in bond prices. Among potential applications, the framework can be used for pricing and hedging credit derivatives that are contingent on the default event and/or recovery levels. Empirical implementation of these models suggests two central findings. First, the recovery concept that specifies recovery as a fraction of the discounted par value has broader empirical support. Second, parametric debt valuation models can provide a useful assessment of recovery rates embedded in bond prices. This article has attempted to model recovery and comprehend their impact on debt values.


Download Full text
Download Full text
Cite this item
Gurdip Bakshi & Dilip B. Madan & Frank X. Zhang, Understanding the role of recovery in default risk models: empirical comparisons and implied recovery rates, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2001-37, 2001.
More from this series
JEL Classification:
Subject headings:
Keywords: Credit ; Risk ; Econometric models
For corrections, contact Ryan Wolfslayer ()
Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

Privacy Legal