On the Dependence Between Default Risk and Recovery Rates in Structural Models
47 Pages Posted: 10 Oct 2020
Date Written: August 18, 2020
We define several concepts of dependence between default risk and recovery risk, in a factor model framework. These concepts are illustrated and compared from the perspective of structural models: Merton (1974)’s single horizon and single firm model, multi-factor extensions, possibly under a portfolio approach. Some first-passage time models are discussed too: Kou’s (2002) model and some of its extensions, in particular by adding self-exciting features. We evaluate the different concepts of “default/recovery” dependencies analytically when it is possible, otherwise by simulation.
Keywords: default probabilities, recovery rates, dependence
JEL Classification: G11, G12, G17
Suggested Citation: Suggested Citation