European Banks' Implied Recovery Rates

30 Pages Posted: 2 Feb 2017 Last revised: 6 Mar 2017

See all articles by Wouter Heynderickx

Wouter Heynderickx

Joint Research Center of the European Commission; KU Leuven - Department of Mathematics

Jessica Cariboni

Joint Research Center of the European Commission

Wim Schoutens

KU Leuven - Department of Mathematics

Bert F. Smits

University of Antwerp - Department of Accounting & Finance; European Union - Directorate General for Competition

Date Written: December 2, 2016

Abstract

We examine recovery rates of the European banking sector. To this end, we employ information embedded in credit default swaps (CDS) with different levels of seniority. To estimate implied recovery rates, we extend the model of Schlafer and Uhrig-Homburg (2014) and include absolute priority violation. We fit the extended model and find that the implied recovery rates are much higher than the ones usually applied in pricing formulas. Since the implied recovery rates are estimated from traded instruments, we obtain recovery rates under the so-called pricing measure Q. They incorporate potentially risk premia and differ from physical or historical rates. We also attempt to estimate the impact of the new resolution regulation in the EU on implied recovery rates. When we compare implied recovery rates with historical ones, we observe an underestimation of the recovery risk premium for senior debt and subordinated debt. However, the negative risk premium on subordinated debt has a larger magnitude. Our results are relevant for pricing models of default-prone instruments and risk management practices that require implied recovery and default rates.

Keywords: Implied recovery rate, Absolute priority rule violation, Debt pricing, Recovery risk, Credit derivatives

JEL Classification: G13, G33

Suggested Citation

Heynderickx, Wouter and Cariboni, Jessica and Schoutens, Wim and Smits, Bert F., European Banks' Implied Recovery Rates (December 2, 2016). Available at SSRN: https://ssrn.com/abstract=2909842 or http://dx.doi.org/10.2139/ssrn.2909842

Wouter Heynderickx (Contact Author)

Joint Research Center of the European Commission ( email )

Via E. Fermi 2749
Brussels, B-1049
Belgium

KU Leuven - Department of Mathematics ( email )

Celestijnenlaan 200 B
Leuven, B-3001
Belgium

Jessica Cariboni

Joint Research Center of the European Commission ( email )

Via E. Fermi 2749
1049
Belgium

Wim Schoutens

KU Leuven - Department of Mathematics ( email )

Celestijnenlaan 200 B
Leuven, B-3001
Belgium

Bert F. Smits

University of Antwerp - Department of Accounting & Finance ( email )

Faculty of Applied Economics
Prinsstraat 13
Antwerp, B-2000
Belgium

European Union - Directorate General for Competition ( email )

Place Madou, Madouplein 1
Saint-Josse-ten-Noode/Sint-Joost-ten-Noode
Brussels, B-1049
Belgium

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
85
Abstract Views
600
rank
369,806
PlumX Metrics