Recovery rates, default probabilities, and the credit cycle

Max Bruche and Carlos González-Aguado ()

Journal of Banking & Finance, 2010, vol. 34, issue 4, 754-764

Abstract: In recessions, the number of defaulting firms rises. On top of this, the average amount recovered on the bonds of defaulting firms tends to decrease. This paper proposes an econometric model in which this joint time-variation in default rates and recovery rate distributions is driven by an unobserved Markov chain, which we interpret as the "credit cycle". This model is shown to fit better than models in which this joint time-variation is driven by observed macroeconomic variables. We use the model to quantitatively assess the importance of allowing for systematic time-variation in recovery rates, which is often ignored in risk management and pricing models.

Keywords: Credit; Recovery; rate; Default; probability; Business; cycle; Capital; requirements; Markov; chain (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (96)

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Related works:
Working Paper: Recovery Rates, Default Probabilities and the Credit Cycle (2006)
Working Paper: Recovery rates, default probabilities and the credit cycle (2006)
Working Paper: Recovery Rates, Default Probabilities and the Credit Cycle (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:34:y:2010:i:4:p:754-764

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