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The Link between Default and Recovery Rates: Theory, Empirical Evidence and Implications
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TLDR
The authors analyzes the association between aggregate default and recovery rates on credit assets, and seeks to empirically explain this critical relationship, concluding that aggregate recovery rates are basically a function of supply and demand for the securities, with default rates playing a pivotal role.Abstract:
This paper analyzes the association between aggregate default and recovery rates on credit assets, and seeks to empirically explain this critical relationship. We examine recovery rates on corporate bond defaults, over the period 1982-2002. Our econometric univariate and multivariate models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. The central thesis is that aggregate recovery rates are basically a function of supply and demand for the securities, with default rates playing a pivotal role. Such a link would bring about a significant increase in both expected and unexpected losses as measured by some widespread credit risk models, and would affect the procyclicality effects of the New Basel Capital Accord. Our results have also important implications for investors in corporate bonds and bank loans, and for all markets (e.g., securitizations, credit derivatives, etc.) which depend on recovery rates as a key variable.read more
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Measuring default risk premia from default swap rates and EDFs
TL;DR: In this article, the authors estimate recent default risk premia for U.S. corporate debt, based on a close relationship between default probabilities, as estimated by Moody's KMV EDFs, and default swap (CDS) market rates.
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Affine Point Processes and Portfolio Credit Risk
TL;DR: The authors analyzes a family of multivariate point process models of correlated event timing whose arrival intensity is driven by an affine jump diffusion and shows that a simple model variant can capture the default clustering implied by index and tranche market prices during September 2008, a month that witnessed significant volatility.
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Market Conditions, Default Risk and Credit Spreads
Dragon Yongjun Tang,Hong Yan +1 more
TL;DR: The authors empirically examined the impact of the interaction between market and default risk on corporate credit spreads using credit default swap (CDS) spreads, and found that average credit spreads decrease in GDP growth rate, but increase in nominal GDP growth volatility and jump risk in the equity market.
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The Risk-Adjusted Cost of Financial Distress*
Heitor Almeida,Thomas Philippon +1 more
TL;DR: In this article, the authors estimate the present value of distress costs using risk-adjusted default probabilities derived from corporate bond spreads and show that marginal distress costs can be as large as the marginal tax benefits of debt derived by Graham.
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Extensions to the Gaussian copula: random recovery and random factor loadings
TL;DR: In this article, two new models of portfolio default loss are presented, which extend the standard Gaussian copula model yet preserve tractability and computational efficiency, and can generate highly significant pricing effects such as fat tails and a correlation "skew" in synthetic CDO tranche prices.
References
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On the pricing of corporate debt: the risk structure of interest rates
TL;DR: In this article, the American Finance Association Meeting, New York, December 1973, presented an abstract of a paper entitled "The Future of Finance: A Review of the State of the Art".
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Valuing corporate securities: some effects of bond indenture provisions
Fischer Black,John C. Cox +1 more
TL;DR: In this paper, the effects of safety covenants, subordination arrangements, and restrictions on the financing of inter-bank transactions are analyzed for option pricing in the context of security indentures.
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A Simple Approach to Valuing Risky Fixed and Floating Rate Debt
TL;DR: In this article, the authors developed a simple approach to valuing risky corporate debt that incorporates both default and interest rate risk, and used this approach to derive simple closed-form valuation expressions for fixed and floating rate debt.
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Pricing Derivatives on Financial Securities Subject to Credit Risk
TL;DR: In this article, a new methodology for pricing and hedging derivative securities involving credit risk is proposed, based on the foreign currency analogy of Jarrow and Turnbull (1991) to decompose the dollar payoff from a risky security into a certain payoff and a spot exchange rate.
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On Cox Processes and Credit Risky Securities
TL;DR: It is shown how to generalize a model of Jarrow, Lando and Turnbull (1997) to allow for stochastic transition intensities between rating categories and into default to reduce the technical issues of modeling credit risk.