Life after Default: Dealer Intermediation and Recovery in Defaulted Corporate Bonds

Abstract

We examine the trading and pricing of defaulted U.S. corporate bonds. Defaulted bonds are actively traded since the bonds’ natural holders change from buy-and-hold to specialized vulture investors. We document that intermediation after default shifts to dealers with prior expertise in the defaulted bond. These primary dealers locate higher-valuation counterparties in longer intermediation chains and absorb more order flow in their inventory than other dealers. The switch to trading with primary dealers raises recovery rates by 8%. Our results highlight the importance of dealers’ expertise in intermediating specific corporate bonds which stabilizes market functioning and lowers credit risk ex-ante.

Keywords: corporate default, corporate bonds, recovery rates, over-the-counter markets, dealer networks

JEL Classification: G12, G14, G24