Recovery Rates: Uncertainty Certainly Matters

Abstract

Previous studies identify default rates as the main systematic determinant of bonds' recovery rates. In this work, we revisit this paradigm by investigating the impact of another factor: economic uncertainty. We study the influence of the latter and the one of traditional variables on the shape of recovery rates distributions, rather than on recovery rates themselves. Based on a wide sample of American default issues and statistical methods tailored to recovery rates data specificities, we show that economic uncertainty is the most important systematic determinant of recovery rates distributions. By contrast, default rate remains a key determinant of the dispersion of these distributions, but not for their means. Taking this evidence into account is critical for the sound implementation of stochastic recovery rates models used by financial institutions for the computation of regulatory capital.

Keywords: Recovery rate, Loss given default, Corporate bond, Credit risk, Uncertainty

JEL Classification: G21, G28, G33