We examine recovery rates of defaulted bonds in the US corporate bond market, based on a complete set of traded prices and volumes. A study of the trading microstructure around various types of default events is provided. We document temporary price pressure with high trading volumes on the default day and the following 30 days, and low trading activity thereafter. Based on this analysis, we determine market-based recovery rates and quantify various liquidity measures. We study the relation between the recovery rates and these measures, considering additionally a comprehensive set of bond characteristics, firm fundamentals, and macroeconomic variables.

We use credit default swaps (CDS) trading data to demonstrate that the credit risk of reference firms, reflected in rating downgrades and bankruptcies, increases significantly upon the inception of CDS trading, a finding that is robust after controlling for the endogeneity of CDS trading. Additionally, distressed firms are more likely to file for bankruptcy if they are linked to CDS trading. Furthermore, firms with more “no restructuring” contracts than other types of CDS contracts (i.e., contracts that include restructuring) are more adversely affected by CDS trading, and the number of creditors increases after CDS trading begins, exacerbating creditor coordination failure in the resolution of financial distress.