Pricing the Risk of Recovery in Default with Apr Violation

41 Pages Posted: 14 Apr 2002

See all articles by Haluk Unal

Haluk Unal

University of Maryland - Robert H. Smith School of Business

Levent Guntay

Federal Deposit Insurance Corporation (FDIC)

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: August 3, 2001

Abstract

This paper proposes a simple approach to infer the risk neutral density of recovery rates implied by the prices of the debt securities of a firm. The proposed approach is independent of modeling default arrival rates and allows for the violation of absolute priority rule (APR). The paper demonstrates that a new statistic, the adjusted relative spread, captures risk neutral recovery information in debt prices. Interest rates and firm tangible assets are shown to be significant determinants of the price of recovery. An application illustrates the pricing of credit derivatives written on the realized recovery rate.

Keywords: Recovery rates, APR violation, Risky debt pricing, Credit risk, Credit derivatives

JEL Classification: G130, G330

Suggested Citation

Unal, Haluk and Guntay, Levent and Madan, Dilip B., Pricing the Risk of Recovery in Default with Apr Violation (August 3, 2001). Available at SSRN: https://ssrn.com/abstract=304219 or http://dx.doi.org/10.2139/ssrn.304219

Haluk Unal (Contact Author)

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

College Park, MD 20742-1815
United States
301-405-2256 (Phone)
301-405 0359 (Fax)

Levent Guntay

Federal Deposit Insurance Corporation (FDIC) ( email )

550 17th Street NW
Washington, DC 20429
United States
202-8986819 (Phone)

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)

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