A false sense of security
Credit portfolio models often assume that recovery rates are independent of default probabilities. Here, Jon Frye presents empirical evidence showing that such assumptions are wrong. Using US historical default data, he shows that not only are recovery rates sensitive to the economic cycle, but also that they vary more for senior debt than for junior debt categories.
Risk
Online References:
Allen L and A Saunders, 2002. A survey of cyclical effects in credit risk measurement models.
Altman E, A Resti and A Sironi 2001. Analyzing and explaining default recovery rates.
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