Federal Dposit InsuranceCorporation• Center for Financial Researchh
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
FDIC Center for Financial Research
Working Paper
No. 2006-06
Understanding the Role of Recovery in Default Risk Models:
Empirical Comparisons and Implied Recovery Rates
August 2006
Empirical Comparisons and Implied Recovery Rates
kkk
An Empirical
An Empirical Analysis
State-
Efraim Benmel Efraim Benmelech May, 2005
June 20
May , 2005 Asset S2005-14
September 2005
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
FDIC Center for Financial Research
Working Paper
No. 2006-06
Understanding the Role of Recovery in Default Risk Models:
Empirical Comparisons and Implied Recovery Rates
August 2006
Empirical Comparisons and Implied Recovery Rates
kkk
An Empirical
An Empirical Analysis
State-
Efraim Benmel Efraim Benmelech May, 2005
June 20
May , 2005 Asset S2005-14
September 2005
Understanding the Role of Recovery in Default Risk Models:
Empirical Comparisons and Implied Recovery Rates∗
Gurdip Bakshia† Dilip Madanb‡ Frank Zhangc§
aSmith School of Business, University of Maryland, College Park, MD 20742, USA
b Smith School of Business, University of Maryland, College Park, MD 20742, USA
c Morgan Stanley, 750 Seventh Avenue, New York, NY 110019, USA
(this version September 6, 2006)
Abstract
This article presents a framework for studying the role of recovery on defaultable debt prices for a wide
class of processes describing recovery rates and default probability. These debt models have the ability to
differentiate the impact of recovery rates and default probability, and can be employed to infer the market
expectation of recovery rates implicit in bond prices. Empirical implementation of these models suggests two
central findings. First, the recovery concept that specifies recovery as a fraction of the discounted par value
has broader empirical support. Second, parametric debt valuation models can provide a useful assessment of
recovery rates embedded in bond prices.
JEL Classification: G0, G10, G11, G12, G13, C5.
Keywords: Recovery; default risk; defaultable coupon bonds, corporate bond pricing, recovery payout as a
fraction of face, recovery as a fraction of pre-default debt values, recovery as a fraction of the present value
of face, implied recovery.
∗For helpful comments and discussions, we thank Viral Acharya, Andrea Buraschi, Mark Carey, Ren-Raw Chen, John Dai, Darrell
Duffie, Greg Duffee, Jean Helwege, Steve Heston, Jingzhi (Jay) Huang, Bob Jarrow, Paul Kupiec, David Lando, Richard McLean,
Jun Pan, Matt Pritsker, Ken Singleton, Chris Telmer, Haluk Unal, and Liuren Wu. Seminar participants at the 2004 American
finance association meetings, 8th annual Chinese finance association meetings (New York University), FDIC, Federal Reserve Board,
University of New Orleans, and Rutgers University provided several useful suggestions. We welcome comments, including references
to related papers we have inadvertently overlooked.
†Tel.: +1-301-405-2261; fax: +1-301-405-0359. E-mail address: gbakshi@rhsmith.umd.edu.
‡Tel.: +1-301-405-2127; fax: +1-301-405-0359. E-mail address: dbm@rhsmith.umd.edu.
§Tel.: +1-212-762-2542; fax: +1-212-762-0696. E-mail address: Xiaoling.Zhang@morganstanley.com.
Empirical Comparisons and Implied Recovery Rates∗
Gurdip Bakshia† Dilip Madanb‡ Frank Zhangc§
aSmith School of Business, University of Maryland, College Park, MD 20742, USA
b Smith School of Business, University of Maryland, College Park, MD 20742, USA
c Morgan Stanley, 750 Seventh Avenue, New York, NY 110019, USA
(this version September 6, 2006)
Abstract
This article presents a framework for studying the role of recovery on defaultable debt prices for a wide
class of processes describing recovery rates and default probability. These debt models have the ability to
differentiate the impact of recovery rates and default probability, and can be employed to infer the market
expectation of recovery rates implicit in bond prices. Empirical implementation of these models suggests two
central findings. First, the recovery concept that specifies recovery as a fraction of the discounted par value
has broader empirical support. Second, parametric debt valuation models can provide a useful assessment of
recovery rates embedded in bond prices.
JEL Classification: G0, G10, G11, G12, G13, C5.
Keywords: Recovery; default risk; defaultable coupon bonds, corporate bond pricing, recovery payout as a
fraction of face, recovery as a fraction of pre-default debt values, recovery as a fraction of the present value
of face, implied recovery.
∗For helpful comments and discussions, we thank Viral Acharya, Andrea Buraschi, Mark Carey, Ren-Raw Chen, John Dai, Darrell
Duffie, Greg Duffee, Jean Helwege, Steve Heston, Jingzhi (Jay) Huang, Bob Jarrow, Paul Kupiec, David Lando, Richard McLean,
Jun Pan, Matt Pritsker, Ken Singleton, Chris Telmer, Haluk Unal, and Liuren Wu. Seminar participants at the 2004 American
finance association meetings, 8th annual Chinese finance association meetings (New York University), FDIC, Federal Reserve Board,
University of New Orleans, and Rutgers University provided several useful suggestions. We welcome comments, including references
to related papers we have inadvertently overlooked.
†Tel.: +1-301-405-2261; fax: +1-301-405-0359. E-mail address: gbakshi@rhsmith.umd.edu.
‡Tel.: +1-301-405-2127; fax: +1-301-405-0359. E-mail address: dbm@rhsmith.umd.edu.
§Tel.: +1-212-762-2542; fax: +1-212-762-0696. E-mail address: Xiaoling.Zhang@morganstanley.com.