A Market-Based Study of the Cost of Default
EFA 2011 Stockholm Meetings Paper
56 Pages Posted: 19 Mar 2010 Last revised: 22 Aug 2012
Date Written: March 2012
Although the cost of financial distress is a central issue in capital structure and credit risk studies, reliable estimates of its size are difficult to come by. This paper proposes a novel method of extracting the cost of default from the change in the market value of a firm's assets upon default. Using a large sample of firms with observed prices of debt and equity that defaulted over 14 years, we estimate the cost of default for an average defaulting firm to be 21.7% of the market value of assets. The costs vary from 14.7% for bond renegotiations to 30.5% for bankruptcies, and are substantially higher for investment-grade firms (28.8%) than for highly-levered bond issuers (20.2%), which extant estimates are based on exclusively.
Keywords: Default, Bankruptcy, Renegotiation, Costs of financial distress, Structural models, Credit risk
JEL Classification: G21, G30, G33
Suggested Citation: Suggested Citation