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

See all articles by Benjamin Bade

Benjamin Bade

Leibniz Universit├Ąt Hannover

Daniel Roesch

University of Regensburg

Harald (Harry) Scheule

University of Technology Sydney (UTS) - School of Finance and Economics; Financial Research Network

Multiple version iconThere are 2 versions of this paper

Date Written: August 27, 2010

Abstract

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

Bade, Benjamin and Roesch, Daniel and Scheule, Harald, Default and Recovery Risk Dependencies in a Simple Credit Risk Model (August 27, 2010). European Financial Management, Vol. 17, No. 1, 2011, pp. 120-144, Available at SSRN: https://ssrn.com/abstract=2349263

Benjamin Bade

Leibniz Universit├Ąt Hannover ( email )

Institut fur Rechnungslegung und WP
Koenigsworther Platz 1
Hannover, 30167
Germany

Daniel Roesch (Contact Author)

University of Regensburg ( email )

Chair of Statistics and Risk Management
Faculty of Business, Economics and BIS
Regensburg, 93040
Germany

HOME PAGE: http://www-risk.ur.de/

Harald Scheule

University of Technology Sydney (UTS) - School of Finance and Economics ( email )

P.O. Box 123
Broadway, NSW 2007
Australia

HOME PAGE: http://https://www.uts.edu.au/staff/harald.scheule

Financial Research Network ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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