Default and Recovery Risk Dependencies in a Simple Credit Risk Model
European Financial Management, Vol. 17, No. 1, 2011, pp. 120-144
36 Pages Posted: 10 Nov 2013
Date Written: August 27, 2010
This paper provides evidence for the relationship between credit quality, recovery rate, and correlation. The paper finds that rating grade, rating shift, and macroeconomic factors provide a highly significant explanation for default risk and recovery risk of US bond issues. The empirical data suggest that default and recovery processes are highly correlated. Therefore, a joint approach is required for estimating time-varying default probabilities and recovery rates that are conditional on default. This paper develops and applies such a model.
Keywords: Asset Value, Correlation, Credit Portfolio, Loss Given Default, Merton Model, Probability of Default, Recovery, Volatility
JEL Classification: G20, G28, C51
Suggested Citation: Suggested Citation