Understanding the Role of Recovery in Default Risk Models: Empirical Comparisons and Implied Recovery Rates

32 Pages Posted: 24 Oct 2003

See all articles by Dilip B. Madan

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business

Gurdip Bakshi

Fox School of Business; Temple University - Fox School of Business and Management

Frank Xiaoling Zhang

Morgan Stanley

Date Written: September 2006

Abstract

This article presents a framework for studying the role of recovery on defaultable debt prices (for a wide class of processes describing recovery rates and default probability). These debt models have the ability to differentiate the impact of recovery rates and default probability, and can be utilized to invert the market expectation of recovery rates implicit in bond prices. Empirical implementation of these models suggests two central findings. First, the recovery concept that specifies recovery as a fraction of the discounted par value has broader empirical support. Second, parametric debt valuation models can provide a useful assessment of recovery rates embedded in bond prices. This article has attempted to model recovery and comprehend their impact on debt values.

JEL Classification: G10, G12, G13

Suggested Citation

Madan, Dilip B. and Bakshi, Gurdip S. and Bakshi, Gurdip S. and Zhang, Frank Xiaoling, Understanding the Role of Recovery in Default Risk Models: Empirical Comparisons and Implied Recovery Rates (September 2006). FDIC CFR Working Paper No. 06, EFA 2004 Maastricht Meetings Paper No. 3584, FEDS Working Paper, AFA 20004 Meetings, Available at SSRN: https://ssrn.com/abstract=285940 or http://dx.doi.org/10.2139/ssrn.285940

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2127 (Phone)
301-314-9157 (Fax)

Gurdip S. Bakshi

Temple University - Fox School of Business and Management ( email )

Philadelphia, PA 19122
United States

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Frank Xiaoling Zhang (Contact Author)

Morgan Stanley ( email )

1585 Broadway
New York, NY 10036
United States

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