Default and Recovery Risk Dependencies in a Simple Credit Risk Model |
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| Authors: | Benjamin Bade Daniel Rösch Harald Scheule |
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| Institution: | 1. Institute of Banking & Finance, Leibniz University of Hannover, K?nigsworther Platz 1, 30167 Hannover, GermanyE‐mail: Benjamin.Bade@finance.uni‐hannover.de;2. Institute of Banking & Finance, Leibniz University of Hannover, K?nigsworther Platz 1, 30167 Hannover, GermanyE‐mail: Daniel.Roesch@finance.uni‐hannover.de;3. Department of Finance, Faculty of Economics and Commerce, University of Melbourne, Victoria 3010, AustraliaE‐mail: hscheule@unimelb.edu.au |
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| Abstract: | This paper provides evidence for the relationship between credit quality, recovery rate, and correlation. The paper finds that rating grade, rating shift, and macroeconomic factors provide a highly significant explanation for default risk and recovery risk of US bond issues. The empirical data suggest that default and recovery processes are highly correlated. Therefore, a joint approach is required for estimating time‐varying default probabilities and recovery rates that are conditional on default. This paper develops and applies such a model. |
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| Keywords: | asset value correlation credit portfolio loss given default Merton model probability of default recovery volatility G20 G28 C51 |
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