MODELING THE RECOVERY RATE IN A REDUCED FORM MODEL

Xin Guo, Robert Jarrow () and Yan Zeng

Mathematical Finance, 2009, vol. 19, issue 1, 73-97

Abstract: This paper provides a model for the recovery rate process in a reduced form model. After default, a firm continues to operate, and the recovery rate is determined by the value of the firm's assets relative to its liabilities. The debt recovers a different magnitude depending upon whether or not the firm enters insolvency and bankruptcy. Although this recovery rate process is similar to that used in a structural model, the reduced form approach is maintained by utilizing information reduction in the sense of Guo, Jarrow, and Zeng. Our model is able to provide analytic expressions for a firm's default intensity, bankruptcy intensity, and zero‐coupon bond prices both before and after default.

Date: 2009
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