Restructuring Risk in Credit Default Swaps: An Empirical Analysis
32 Pages Posted: 17 Mar 2006 Last revised: 9 Aug 2014
Date Written: December 28, 2006
This paper estimates the price for restructuring risk in the U.S. corporate bond market during 1999-2005. Comparing quotes from default swap (CDS) contracts with a restructuring event and without, we find that the average premium for restructuring risk represents 6% to 8% of the swap rate without restructuring. We show that the restructuring premium depends on firm-specific balance-sheet and macroeconomic variables. And, when default swap rates without a restructuring event increase, the increase in restructuring premia is higher for low-credit-quality firms than for high-credit-quality firms. We propose a reduced-form arbitrage-free model for pricing default swaps that explicitly incorporates the distinction between restructuring and default events. A case study illustrating the model’s implementation is provided.
Keywords: credit default swaps, restructuring credit event, reduced-form credit risk modeling
JEL Classification: G13
Suggested Citation: Suggested Citation