Journal of Financial and Quantitative Analysis Vol. 49 No. 1 2014
The Cross Section of Recovery Rates and Default Probabilities Implied by Credit Default Swap Spreads
Abstract
Rather than assuming a fixed recovery rate in estimation, we estimate recovery rates from credit default swap spreads, using 3 years of daily data on 152 corporations. We use a quadratic pricing model, which ensures nonnegative default probabilities and recovery rates. The estimated cross section of recovery rates is plausible, with an average recovery rate of 54% and substantial cross-sectional variation. Estimated 5-year default probabilities are on average 67% higher than default probabilities obtained using the standard 40% recovery assumption. This finding critically impacts the valuation of structured credit products. Larger firms and firms with more tangible assets have higher recovery rates.
- DOI
- 10.1017/s0022109014000088
- Volume
- 49
- Issue
- 1
- Pages
- 193-220
- Language
- en
- Sources
- openalex bibtex:phds-export.bib crossref