Default recovery rates and aggregate fluctuations

Giacomo Candian and Mikhail Dmitriev

Journal of Economic Dynamics and Control, 2020, vol. 121, issue C

Abstract: Default recovery rates in the US are highly volatile and pro-cyclical. We show that state-of-the-art models with a Bernanke-Gertler-Gilchrist financial accelerator mechanism imply that recovery rates are flat over the cycle. We propose a model where financially-constrained entrepreneurs face an idiosyncratic cost of redeploying liquidated capital. The resulting endogenous liquidation costs magnify the effect of the financial accelerator. We fit the model to US data and find that it explains a substantial amount of variation in recovery rates, including their sharp contraction at the onset of the Great Recession. Our mechanism delivers a more flexible relationship between credit spreads and macroeconomic variables and leads to novel policy implications about the effectiveness of subsidies for liquidated assets.

Keywords: Financial accelerator; Financial frictions; Recovery rates; Liquidation costs (search for similar items in EconPapers)
JEL-codes: C68 E44 E61 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (6)

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Related works:
Working Paper: Default Recovery Rates and Aggregate Fluctuations (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:121:y:2020:i:c:s0165188920301792

DOI: 10.1016/j.jedc.2020.104011

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