Preliminary! Incomplete Draft! Measuring Systematic Risk in Recoveries on Defaulted Debt I: Firm-Level Ultimate LGDs

Several recent empirical papers report evidence of significant systematic variation in recovery rates on defaulted corporate debt, implying that the convenient assumption of independent recovery rates found in most defaultable debt pricing models and portfolio credit risk models is unrealistic. However, such work has used recoveries on individual assets. These are claims on the value of the bankrupt firm at emergence, so systematic variation in such firm value is the most natural source of systematic variation in recoveries. We examine the aggregate recovery at emergence on the debt of each firm in a sample of bankrupt firms. We find mixed evidence of systematic variation. Such evidence is driven largely by experience in a single historical episode and point estimates and statistical significance are sensitive to details of the empirical specification. Our evidence about predictors of recovery suggests that interactions between the default decision and recovery rates may be more complex than existing models imply.