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The Term Structure of Expected Recovery Rates

Published online by Cambridge University Press:  19 October 2018

Hitesh Doshi ,
Redouane Elkamhi  and
Chayawat Ornthanalai
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Abstract

There is widespread agreement that corporate debts’ recovery rates are time varying, but empirical work in this area is limited. We show that the joint information from the term structure of senior and subordinate credit default swaps can identify the level and the dynamics of recovery rates. We estimate a reduced-form no-arbitrage model on 46 firms across different industries. We find that the term structure of expected recovery rates is, on average, downward sloping. However, an inversion occurs during the 2008 crisis, suggesting the market expects higher recoveries conditional on short-term survival. The inversion is more pronounced for firms in distressed industries.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 6 , December 2018 , pp. 2619 - 2661
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

We are grateful for helpful comments from an anonymous referee, Sudheer Chava, Jan Ericsson, Jarrad Harford (the editor), Kris Jacobs, and Kenneth Singleton (Western Finance Association meetings discussant). This article has benefited from comments by conference and seminar participants at the Bank of Canada, University of Hong Kong, McGill University, Federal Reserve Bank of New York, University of Houston, Stockholm School of Economics, ESSEC, Indian School of Business, Indiana University, University of Iowa, Hong Kong University of Science and Technology, Nanyang Technological University, University of Melbourne, and the 2011 Western Finance Association Meetings. Financial support from the Social Sciences and Humanities Research Council (SSHRC) of Canada and the Montreal Institute of Structured Finance and Derivatives (IFSID) is gratefully acknowledged.

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