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The Economic Role of Jumps and Recovery Rates in the Market for Corporate Default Risk

by Paul Schneider of the University of Warwick,
Leopold Sögner of Institute for Advanced Studies, Vienna, and
Tanja Ve˛a of Vienna University of Economics and Business

May 14, 2009

Abstract: Using an extensive cross-section of US corporate CDS this paper offers an economic understanding of implied loss given default (LGD) and jumps in default risk. We formulate and underpin empirical stylized facts about CDS spreads, which are then reproduced in our affine intensity-based jump-diffusion model. Implied LGD is well identified, with obligors possessing substantial tangible assets expected to recover more. Sudden increases in the default risk of investment-grade obligors are higher relative to speculative grade. The probability of structural migration to default is low for investment-grade and heavily regulated obligors because investors fear distress rather through rare but devastating events.

JEL Classification: C11, C15, C51, C52, E43, G13.

Keywords: credit default swaps, loss given default, stochastic intensity, jump-diffusion, Markov chain Monte Carlo estimation.

Published in: Journal of Financial and Quantitative Analysis, Vol. 45, No. 6, (2010), pp. 1517-1547.

Previously titled: Jumps and Recovery Rates Inferred from Corporate CDS Premia

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