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MODELING THE RECOVERY RATE IN A REDUCED FORM MODEL
Author(s) -
Guo Xin,
Jarrow Robert A.,
Zeng Yan
Publication year - 2009
Publication title -
mathematical finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.98
H-Index - 81
eISSN - 1467-9965
pISSN - 0960-1627
DOI - 10.1111/j.1467-9965.2008.00358.x
Subject(s) - bankruptcy , insolvency , debt , loss given default , economics , monetary economics , recovery rate , bond , default risk , econometrics , value (mathematics) , credit risk , business , actuarial science , microeconomics , finance , computer science , capital requirement , chemistry , chromatography , incentive , machine learning
This paper provides a model for the recovery rate process in a reduced form model. After default, a firm continues to operate, and the recovery rate is determined by the value of the firm's assets relative to its liabilities. The debt recovers a different magnitude depending upon whether or not the firm enters insolvency and bankruptcy. Although this recovery rate process is similar to that used in a structural model, the reduced form approach is maintained by utilizing information reduction in the sense of Guo, Jarrow, and Zeng. Our model is able to provide analytic expressions for a firm's default intensity, bankruptcy intensity, and zero‐coupon bond prices both before and after default.