Restructuring Risk in Credit Default Swaps: An Empirical Analysis

Antje Berndt, Robert Jarrow () and ChoongOh Kang

No 2006-E30, GSIA Working Papers from Carnegie Mellon University, Tepper School of Business

Abstract: 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.

Date: 2006-12
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Journal Article: Restructuring risk in credit default swaps: An empirical analysis (2007)
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