The Cross Section of Recovery Rates and Default Probabilities Implied by Credit Default Swap Spreads

Redouane Elkamhi, Kris Jacobs and Xuhui Pan

Journal of Financial and Quantitative Analysis, 2014, vol. 49, issue 1, 193-220

Abstract: Rather than assuming a fixed recovery rate in estimation, we estimate recovery rates from credit default swap spreads, using 3 years of daily data on 152 corporations. We use a quadratic pricing model, which ensures nonnegative default probabilities and recovery rates. The estimated cross section of recovery rates is plausible, with an average recovery rate of 54% and substantial cross-sectional variation. Estimated 5-year default probabilities are on average 67% higher than default probabilities obtained using the standard 40% recovery assumption. This finding critically impacts the valuation of structured credit products. Larger firms and firms with more tangible assets have higher recovery rates.

Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:cup:jfinqa:v:49:y:2014:i:01:p:193-220_00

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