a1 Finance Group, Warwick Business School, University of Warwick, Scarman Road, CV4 7AL Coventry, UK. email@example.com
a2 Department of Economics and Finance, Institute for Advanced Studies, Stumpergasse 56, 1060 Vienna, Austria. firstname.lastname@example.org
a3 Institute for Finance, Banking and Insurance, Vienna University of Economics and Business, Heiligenstädter Straße 46-48, 1190 Vienna, Austria. email@example.com
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.
(Online publication September 17 2010)
A previous version of this paper was circulated as “Jumps and Recovery Rates Inferred from Corporate CDS Premia.” We are thankful to FIRM@WU for access to their high-performance computing resources as well as friendly support, and to Dow Jones for providing us with complete Industry Classification Benchmark (ICB) sector information. We are indebted to Gurdip Bakshi (associate editor and referee), John Peter Château, Gregor Dorfleitner, Hermann Elendner, Peter Feldhütter, Alois Geyer, Michael Gordy, Lotfi Karoui, David Lando, Paul Malatesta (the editor), Franck Moraux, and Stefan Pichler for many helpful comments.