Pricing the Risk of Recovery in Default with APR Violation

Haluk Unal, Dilip Madan and Levent Güntay

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: This paper proposes a simple approach to infer the risk neutral density of recovery rates implied by the prices of the debt securities of a firm. The proposed approach is independent of modeling default arrival rates and allows for the violation of absolute priority rule (APR). The paper demonstrates that a new statistic, the adjusted relative spread, captures risk neutralrecovery information in debt prices. Interest rates and firm tangible assets are shown to be significant determinants of the price of recovery. An application illustrates the pricing of credit derivatives written on the realized recovery rate.

Keywords: Recovery rates; APR violation; Risky debt pricing; Credit risk; Credit deriva-tives (search for similar items in EconPapers)
JEL-codes: G13 G33 (search for similar items in EconPapers)
Date: 2001-08
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:wop:pennin:02-21

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