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The Economic Role of Jumps and Recovery Rates in the Market for Corporate Default Risk

Published online by Cambridge University Press:  17 September 2010

Paul Schneider ,
Leopold Sögner  and
Tanja Veža
Paul Schneider
Affiliation:
Finance Group, Warwick Business School, University of Warwick, Scarman Road, CV4 7AL Coventry, UK. paul.schneider@wbs.ac.uk
Leopold Sögner
Affiliation:
Department of Economics and Finance, Institute for Advanced Studies, Stumpergasse 56, 1060 Vienna, Austria. soegner@ihs.ac.at
Tanja Veža
Affiliation:
Institute for Finance, Banking and Insurance, Vienna University of Economics and Business, Heiligenstädter Straße 46-48, 1190 Vienna, Austria. tanja.veza@wu.ac.at
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Abstract

Using an extensive cross section of U.S. corporate credit default swaps (CDSs), this paper offers an economic understanding of implied loss given default (LGD) and jumps in default risk. We formulate and underpin empirical stylized facts about CDS spreads, which are then reproduced in our affine intensity-based jump-diffusion model. Implied LGD is well identified, with obligors possessing substantial tangible assets expected to recover more. Sudden increases in the default risk of investment-grade obligors are higher relative to speculative grade. The probability of structural migration to default is low for investment-grade and heavily regulated obligors because investors fear distress rather through rare but devastating events.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 6 , December 2010 , pp. 1517 - 1547
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

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