How to Price Recovery Risk

CreditFlux, April 2015

2 Pages Posted: 27 May 2015 Last revised: 13 Jun 2015

See all articles by Albert Cohen

Albert Cohen

Michigan State University - Department of Mathematics; Michigan State University - Department of Statistics and Probability

Nick Costanzino

Jefferies Group; New York University - Department of Finance and Risk Engineering

Date Written: May 26, 2015

Abstract

We present a method to incorporate stochastic recovery into the classical Merton and Black-Cox models that allows for the separation of the recovery risk premium from the default risk premium. We compute closed-form solutions for zero-coupon bonds, credit spreads and credit default swaps. With some additional complexity, the methodology can also be extended to other credit products, including coupon-bearing bonds.

Suggested Citation

Cohen, Albert and Costanzino, Nick, How to Price Recovery Risk (May 26, 2015). CreditFlux, April 2015, Available at SSRN: https://ssrn.com/abstract=2610927

Albert Cohen (Contact Author)

Michigan State University - Department of Mathematics ( email )

619 Red Cedar Road
C336 Wells Hall
East Lansing, MI 48824
United States
517-355-4592 (Phone)

HOME PAGE: http://www.math.msu.edu

Michigan State University - Department of Statistics and Probability ( email )

619 Red Cedar Road
C336 Wells Hall
East Lansing, MI 48824-1027
United States
517-355-4592 (Phone)

HOME PAGE: http://www.stt.msu.edu

Nick Costanzino

Jefferies Group ( email )

520 Madison Ave
Floor 10
New York, NY 10022
United States

New York University - Department of Finance and Risk Engineering

Brooklyn, NY 11201
United States

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