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Modeling the Recovery Rate in a Reduced Form Model

25 Pages Posted: 17 Jan 2009  

Xin Guo

University of California, Berkeley

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Yan Zeng

affiliation not provided to SSRN

Date Written: 2007-08

Abstract

This paper provides a model for the recovery rate process in a reduced form model. After default, a firm continues to operate, and the recovery rate is determined by the value of the firm's assets relative to its liabilities. The debt recovers a different magnitude depending upon whether or not the firm enters insolvency and bankruptcy. Although this recovery rate process is similar to that used in a structural model, the reduced form approach is maintained by utilizing information reduction in the sense of Guo, Jarrow, and Zeng. Our model is able to provide analytic expressions for a firm's default intensity, bankruptcy intensity, and zero-coupon bond prices both before and after default.

Suggested Citation

Guo, Xin and Jarrow, Robert A. and Zeng, Yan, Modeling the Recovery Rate in a Reduced Form Model (2007-08). Mathematical Finance, Vol. 19, Issue 1, pp. 73-97, January 2009. Available at SSRN: https://ssrn.com/abstract=1327437 or http://dx.doi.org/10.1111/j.1467-9965.2008.00358.x

Xin Guo

University of California, Berkeley

310 Barrows Hall
Berkeley, CA 94720
United States

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Yan Zeng

affiliation not provided to SSRN ( email )

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