The Dependence of Recovery Rates and Defaults
Risk Control Research Paper No. 6/1
28 Pages Posted: 29 Nov 2011
Date Written: February 1, 2006
Abstract
In standard ratings-based models for analyzing credit portfolios and pricing credit derivatives, it is assumed that defaults and recoveries are statistically independent. This paper presents evidence that aggregate quarterly default rates and recovery rates are, in fact, negatively correlated. Using Extreme Value Theory techniques, we show that the dependence affects the tail behavior of total credit loss distributions and leads to higher VaR measures.
Keywords: default rates, recovery rates, extreme value theory, VaR
JEL Classification: G19
Suggested Citation: Suggested Citation
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