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Post by Sapphire Capital on Jul 11, 2008 22:15:33 GMT 4
Anticipating Credit Events Using Credit Default Swaps: An Application to Sovereign Debt Crises JORGE A. CHAN-LAU Structured and Securitized Products Department, IFC, The World Bank Group; International Monetary Fund (IMF) - Research Department; The Fletcher School of Law and Diplomacy -------------------------------------------------------------------------------- CREDIT RISK: MODELS, DERIVATIVES, AND MANAGEMENT, Chapter 9, Niklas Wagner, ed., CRC Press, 2008 Abstract: In reduced-form pricing models, it is usual to assume a fixed recovery rate to obtain the probability of default from credit default swap prices. An alternative credit risk measure is proposed here: the maximum recovery rate compatible with observed prices. The analysis of the recent debt crisis in Argentina using this methodology shows that the correlation between the maximum recovery rate and implied default probabilities turns negative in advance of the credit event realization. This empirical finding suggests that the maximum recovery rate can be used for constructing early warning indicators of financial distress. papers.ssrn.com/sol3/papers.cfm?abstract_id=1124143
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