Template-type: ReDIF-Paper 1.0
Author-Name: Marcin Jaskowski
Author-Workplace-Name: Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam
Author-Name: Michael McAleer
Author-Person: pmc90 
Author-Workplace-Name: Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam.
Title: Estimating Implied Recovery Rates from the Term Structure of CDS Spreads
Abstract: Credit risk models should reflect the observation that the relevant value of collateral is generally not the
	average value of the asset over all possible states of nature. In most cases, the relevant value of collateral for
	the lender is its secondary market value in bad states of nature, where marginal utilities are high. Although the
	negative correlation between recovery rates and default probabilities is well documented, the majority of pricing
	models does not allow for correlation between the two. In this paper, we propose a relatively parsimonious
	reduced-form continuous time model that estimates expected recovery rates and default probabilities from the
	term structure of CDS spreads. The parameters of the model and latent factors driving recovery risk and default
	risk are estimated using a Bayesian MCMC algorithm. We find that the Bayesian deviance information criterion
	(DIC) favors the model with stochastic recovery over constant recovery. We also observe that for companies
	with a good rating, implied constant recovery rates do not difier much from stochastic recovery. However, if a
	company is very risky, then forward stochastic recovery rates are significantly lower at longer maturities.
Classification-JEL: G13, G17, G33, E43.
Keywords: Constant recovery, Stochastic recovery, Implied recovery rate, Term structure, CDS spreads.
Note: For financial support, the second author wishes to acknowledge the Australian Research Council, National Science Council, 
	Taiwan, and the Japan Society for the Promotion of Science.
Length: 31 pages 
Creation-Date: 2012-12  
Number: 2012-28 
X-File-Ref: http://america.sim.ucm.es/repec/ucm/ref/doicae1228.txt
File-URL: https://eprints.ucm.es/id/eprint/17581/1/1228.pdf
File-Format: Application/pdf
Handle: RePEc:ucm:doicae:1228