Extreme Correlation of Defaults and LGDs

Yen-Ting Hu
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Yen-Ting Hu: Department of Economics, Mathematics & Statistics, Birkbeck

No 705, Birkbeck Working Papers in Economics and Finance from Birkbeck, Department of Economics, Mathematics & Statistics

Abstract: This paper conducts a systematic investigation into the correlation between the default rate and three definitions of the recovery rate: price recoveries, settlement recoveries and discounted settlement recoveries. The data suggests a strong linear correlation for price recoveries and a weak one for settlement recoveries, but little or no correlation for discounted settlement recoveries. Using extreme value techniques, I show that the tail dependency for the settlement recoveries is as strong as that for the price recoveries. The probability of high losses (loss given default exceeding 0.9) is consistently higher for the settlement recoveries than for the price recoveries at any level of the quarterly default rate above 0.1%.

Date: 2007-01
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