A Market-Based Study of the Cost of Default

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

Sergei A. Davydenko

University of Toronto - Finance Area

Ilya A. Strebulaev

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

Xiaofei Zhao

University of Texas at Dallas - Naveen Jindal School of Management

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; 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

University of Texas at Dallas - Naveen Jindal School of Management ( email )

800 West Campbell Road, SM 31
Richardson, TX 75080
United States

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