The Economic Role of Jumps and Recovery Rates in the Market for Corporate Default Risk
University of Lugano - Institute of Finance
Institute for Advanced Studies (IHS)
WU Vienna (Vienna University of Economics and Business)
May 14, 2009
Journal of Financial and Quantitative Analysis (JFQA), Forthcoming
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.
Number of Pages in PDF File: 60
Keywords: credit default swaps, credit risk, loss given default, stochastic intensity, jump-diffusion, Markov chain Monte Carlo estimation
JEL Classification: C11, C15, C51, C52, E43, G13Accepted Paper Series
Date posted: March 19, 2008 ; Last revised: May 21, 2009
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