Default Recovery Rates in Credit Risk Modeling: A Review of the Literature and Empirical Evidence

33 Pages Posted: 5 Nov 2008

See all articles by Edward I. Altman

Edward I. Altman

New York University (NYU) - Salomon Center; New York University (NYU) - Department of Finance

Andrea Resti

Bocconi University - Department of Finance

Andrea Sironi

Bocconi University - Department of Finance

Date Written: December 2003

Abstract

Evidence from many countries in recent years suggests that collateral values and recovery rates on corporate defaults can be volatile and, moreover, that they tend to go down just when the number of defaults goes up in economic downturns. This link between recovery rates and default rates has traditionally been neglected by credit risk models, as most of them focused on default risk and adopted static loss assumptions, treating the recovery rate either as a constant parameter or as a stochastic variable independent from the probability of default. This traditional focus on default analysis has been partly reversed by the recent significant increase in the number of studies dedicated to the subject of recovery rate estimation and the relationship between default and recovery rates. This paper presents a detailed review of the way credit risk models, developed during the last thirty years, treat the recovery rate and, more specifically, its relationship with the probability of default of an obligor. Recent empirical evidence concerning this issue is also presented and discussed.

Keywords: credit rating, credit risk, recovery rate, default rate

Suggested Citation

Altman, Edward I. and Resti, Andrea and Sironi, Andrea, Default Recovery Rates in Credit Risk Modeling: A Review of the Literature and Empirical Evidence (December 2003). NYU Working Paper No. S-CDM-03-11, Available at SSRN: https://ssrn.com/abstract=1295797

Edward I. Altman (Contact Author)

New York University (NYU) - Salomon Center ( email )

44 West 4th Street
New York, NY 10012
United States
212-998-0709 (Phone)
212-995-4220 (Fax)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Andrea Resti

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Andrea Sironi

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

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