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Post by Sapphire Capital on Jul 16, 2008 6:10:04 GMT 4
Robust Recovery Risk Hedging MONIKA MULLER Affiliation Unknown SIEGFRIED TRAUTMANN University of Mainz - Faculty of Law and Economics March 4, 2008 Abstract: Credit derivatives are subject to at least two sources of risk: default time and the recovery payment. This paper examines the impact of modeling the recovery payment on hedging strategies in a reduced-form model as well as a Merton-type model. We show that quadratic hedging approaches do only depend on the "expected" recovery payment at default and not the whole shape of the recovery payment distribution. This justifies assuming a "certain" recovery payment conditional on the default time. Hence, this result allows a simplified modeling of credit risk. papers.ssrn.com/sol3/papers.cfm?abstract_id=1102577
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