Understanding the Role of Recovery in Default Risk Models: Empirical Comparisons and Implied Recovery Rates
by Gurdip Bakshi of the University of Maryland,
September 6, 2006
Abstract: This article presents a framework for studying the role of recovery on defaultable debt prices 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 employed to infer the market expectation of recovery rates implicit in bond prices. 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.
JEL Classification: G0, G10, G11, G12, G13, C5.
Keywords: Recovery, default risk, defaultable coupon bonds, corporate bond pricing, recovery payout as a fraction of face, recovery as a fraction of pre-default debt values, recovery as a fraction of the present value of face, implied recovery.
Previously titled: Recovery Risk in Defaultable Debt Models: Empirical comparisons and implied recovery rates