An Empirical Analysis of Bond Recovery Rates: Exploring a Structural View of Default

FEDS Working Paper No. 2005-10

46 Pages Posted: 30 May 2005

See all articles by Daniel M. Covitz

Daniel M. Covitz

Federal Reserve Board - Division of Research & Statistics

Song Han

Federal Reserve Board - Division of Research and Statistics

Date Written: December 2004

Abstract

A frictionless, structural view of default has the unrealistic implication that recovery rates on bonds, measured at default, should be close to 100 percent. This suggests that standard "frictions" such as default delays, corporate-valuation jumps, and bankruptcy costs may be important drivers of recovery rates. A structural view also suggests the existence of nonlinearities in the empirical relationship between recovery rates and their determinants. We explore these implications empirically and find direct evidence of jumps, and also evidence of the predicted nonlinearities. In particular, recovery rates increase as economic conditions improve from low levels, but decrease as economic conditions become robust. This suggests that improving economic conditions tend to boost firm values, but firms may tend to default during particularly robust times only when they have experienced large, negative shocks.

Keywords: Recovery rate, default, credit risk model

JEL Classification: G33, G34, G12

Suggested Citation

Covitz, Daniel M. and Han, Song, An Empirical Analysis of Bond Recovery Rates: Exploring a Structural View of Default (December 2004). FEDS Working Paper No. 2005-10, Available at SSRN: https://ssrn.com/abstract=675987 or http://dx.doi.org/10.2139/ssrn.675987

Daniel M. Covitz (Contact Author)

Federal Reserve Board - Division of Research & Statistics ( email )

20th and C Streets, NW
Mailstop 153
Washington, DC 20551
United States
202-452-5267 (Phone)
202-452-5295 (Fax)

Song Han

Federal Reserve Board - Division of Research and Statistics ( email )

20th & C. St., N.W.
Washington, DC 20551
United States
202-736-1971 (Phone)
202-452-3891 (Fax)

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