Summary |
The finance literature looks at a number of factors to explain risk premia in corporate debt, such as liquidity effects, jump-to-default risk, and contagion risk. Stochastic recovery rates as a source of systematic risk have not received much attention so far, most likely due to the difficulties around decomposing the expected loss. Timo Schlafer exploits the fact that differently-ranking debt instruments of the same issuer face identical default risk but different default-conditional recovery rates. He shows that this allows isolating recovery risk without any of the rigid assumptions employed by priors and implements his approach using credit default swap data.
Contents
• Recovery Rates under the Physical Probability Measure
• Prior Research on the Estimation of Implied Recovery Rates
• Loan-Only Credit Default Swaps
• A Default-Free Metric of Implied Recovery Rates
• The Properties of Implied Recovery Rates
• Risk Aversion in implied Default and Recovery Rates
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