A Market-Based Study of the Cost of Default

56 Pages Posted: 19 Mar 2010 Last revised: 22 Aug 2012

See all articles by Sergei A. Davydenko

Sergei A. Davydenko

University of Toronto - Finance Area

Ilya A. Strebulaev

Stanford University - Graduate School of Business; National Bureau of Economic Research

Xiaofei Zhao

Georgetown University - Robert Emmett McDonough School of Business

Date Written: March 2012

Abstract

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

Davydenko, Sergei A. and Strebulaev, Ilya A. and Zhao, Xiaofei, A Market-Based Study of the Cost of Default (March 2012). AFA 2012 Chicago Meetings Paper, EFA 2011 Stockholm Meetings Paper, Rock Center for Corporate Governance at Stanford University Working Paper No. 124, Available at SSRN: https://ssrn.com/abstract=1571940 or http://dx.doi.org/10.2139/ssrn.1571940

Sergei A. Davydenko (Contact Author)

University of Toronto - Finance Area ( email )

Toronto, Ontario M5S 3E6
Canada

Ilya A. Strebulaev

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Xiaofei Zhao

Georgetown University - Robert Emmett McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States

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