Recovery Rates, Default Probabilities and the Credit Cycle
Carlos González-Aguado () and
Max Bruche
FMG Discussion Papers from Financial Markets Group
Abstract:
Recovery rates are negatively related to default probabilities (Altman et al.,2005). This paper proposes and estimates a model in which this dependence is the result of an unobserved credit cycle: When times are bad, the default probability is high and recovery rates are low; when times are good, the default probability is low and recovery rates are high. The proposed dynamic model is shown to produce a better fit to the data than a standard static approach. It indicates that ignoring the dynamic nature of credit risk could lead to a severe underestimation of credit risk (e.g. by a factor of up to 1.7 in terms of the 95% VaR). Also, the model indicates that the credit cycle is related to but distinct from the business cycle as e.g. determined by the NBER, which might explain why previous studies have found the power of macroeconomic variables in explaining default probabilities and recoveries to be low.
Date: 2006-11
New Economics Papers: this item is included in nep-ban, nep-mac and nep-rmg
References: Add references at CitEc
Citations: View citations in EconPapers (29)
Downloads: (external link)
http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp572.pdf (application/pdf)
Related works:
Journal Article: Recovery rates, default probabilities, and the credit cycle (2010) 
Working Paper: Recovery Rates, Default Probabilities and the Credit Cycle (2006) 
Working Paper: Recovery rates, default probabilities and the credit cycle (2006) 
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
HTML/Text
Persistent link: https://EconPapers.repec.org/RePEc:fmg:fmgdps:dp572
Access Statistics for this paper
More papers in FMG Discussion Papers from Financial Markets Group
Bibliographic data for series maintained by The FMG Administration ().