The Term Structure of Expected Recovery Rates

There is widespread agreement that corporate debts' recovery rates are time-varying, but empirical work in this area is limited. We show that the joint information from the term structure of senior and subordinate credit default swaps can identify the level and the dynamics of recovery rates. We estimate a reduced form no-arbitrage model on 46 firms across different industries. We find that the term structure of expected recovery rates is, on average, downward sloping. However, an inversion occurs during the 2008 crisis, suggesting the market expects higher recoveries conditional on short-term survival. The inversion is more pronounced for firms in distressed industries.

Keywords: Credit Default Swaps (CDS); Stochastic Recovery; Term Structure Seniority; No-Arbitrage

JEL Classification: G01; G12

Suggested Citation: Suggested Citation

Doshi, Hitesh and Elkamhi, Redouane and Ornthanalai, Chayawat, The Term Structure of Expected Recovery Rates (April 30, 2017). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3222968