Conclusion and Outlook
This thesis pursues a new approach to estimating market-implied recovery rates, exploiting the fact that differently-ranking debt instruments of a given issuer face identical arrival risk but different default-conditional recovery rates. It is shown that employing (L)CDSs on two such instruments, it is feasible to construct a metric that is a function only of implied expected recovery rates but void of default risk. Based on this metric and additionally taking into consideration capital structure data, a firm’s entire implied probability distribution of recovery at a particular point in time can be inferred. This proceeding stands out perspicuously against those of priors in that the identification problem is overcome without imposing an assumption-heavy model structure. Most importantly, the pricing measure is chosen such that recovery risk can be separated from default risk without presuming independence.
KeywordsRecovery Rate Capital Structure Credit Default Swap Default Risk Credit Derivative
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