Risk Aversion, the Demand for Risky Assets, and Recoveries on Defaulted Corporate Debt Securities

In this paper we examine whether variation in investors’ demand for risky assets is associated with recoveries on defaulted debt securities. Our examination is motivated by the prediction of standard portfolio separation theorems that an increase in aggregate investor risk aversion is associated with a decrease in the demand for the market portfolio of risky assets. Motivated by this prediction, we hypothesize that, holding all else constant, the value of defaulted corporate debt securities and the value of the collateral backing these securities should be negatively associated with an increase in the risk free asset’s weight in the aggregate investment portfolio. Using data on outstanding U.S. government debt securities, corporate debt securities and equity market capitalization, we present evidence that proxies for changes in the risk-free assets’ (Treasury Bills) weight in the aggregate investment portfolio is negatively associated with recoveries on defaulted corporate debt. J.E.L. Classification Codes: G33, G34, C25, C15, C52.