Distressed Debt Valuation
Distressed Debt Valuation
Distressed Debt Valuation
Estimation
Robert Jarrow
Joint Work with Xin Guo and Haizhi Lin
May 2008
Introduction
Purposes
(it turns out, to solve one, must also solve the other)
Introduction
Results
1. Recovery rate estimates are sensitive to the date selected for
estimation (signi…cant di¤erences between using the recorded
default date and 30 days after).
2. Prices support the belief that the market often recognizes
default before default is recorded.
3. An extended recovery rate model provides a poor …t to
distressed debt prices after the recorded default date
(extension implicit in using 30 day after to estimate recovery
rate).
4. We estimate a new recovery rate process and use it to price
distressed debt. The model …ts market prices well.
Prologue
Structural models
Use management’s information set.
Default can be viewed as the …rst hitting time of the …rm’s asset
value to a liability determined barrier.
If the …rm’s asset value follows a continuous process, the value of a
…rm’s debt does not exhibit a jump at default.
No implications for risky debt prices subsequent to default.
Reduced Form Models
Use market’s information set.
Default modeled as the …rst jump time of a point process.
Debt prices exhibit a negative jump at default.
No implications for risky debt prices subsequent to default.
Prologue
55
s e ri e s 1
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3 0 -S e p -2 0 0 4 2 7 -F e b -2 0 0 5 2 7 -J u l -2 0 0 5 2 4 -De c -2 0 0 5
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0 3 -Oc t -2 0 0 4 3 0 -No v -2 0 0 4 2 7 -J a n -2 0 0 5 2 6 -M a r-2 0 0 5
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2 9 -Se p -2 0 0 4 2 6 -Fe b -2 0 0 5 2 6 -J u l -2 0 0 5 2 3 -De c -2 0 0 5
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0 3 -Ap r-2 0 0 5 3 0 -J u n -2 0 0 5 2 6 -Se p -2 0 0 5 2 3 -De c -2 0 0 5
Bτd = δτ F
Bτd = δτ pτ (T )
Bτd = δτ Bτ
Cross-Sectional Models
N = 96 RT Estimates
Mean 0.4062
Median 0.3452
Standard Deviation 0.2528
First Quartile 0.1692
Third Quartile 0.6374
where 8
< F if RFV
m= pτ (T ) if RT
:
Bτ if RMV .
Assumes that risky debt position is sold at τ, and the model prices
debt as the value of this position. Equivalently,
Rt
Btd = Bτd e τ rs ds
for t τ.
Rτ
b
τ= inf ft : Bt Bτd e t rs ds
g.
τ 180 t τ
20
15
Cases
10
0
0 20 40 60 80 100 120 140 160 180
Days
Figure: N = 73.
Time-Series Models - Revised Recovery Rates
8 Bτ
>
< F if RFV
b Bτ
δτ = p (τ,T )
if RT
>
: Bτ
Bτ if RMV .
Time-Series Models - RFV
4
Density
0
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2
Recov ery Rate Estimates
Time-Series Models - Pricing Tests
Rt
Btd = m b
δτ e τ rs ds + et for t τ.
where
dRt = a(b Rt )dt + σdWt
with a, b, σ are constants and Wt is a standard B.M. under the
martingale measure.
Rt = Ct + Ft Rt 1 + ηt
2
where η t σ
N (0, 2a (1 2e a) and
ba λ a a
At , Ht , Ct b (1 e ) , Ft e
(a + λ ) (a + λ )
Given (a, b, σ, ρ, λ) and (Rt )t τ, estimate
Rτ
ru du a (τ t)
τ= inf ft : Bt Bτd e t e + mb (1 e a (τ t)
)g
τ 180 t τ
Recovery Rate Model - Economic Default Date
Time Between Economic Def ault Date and Announced Def ault Date
35
30
25
20
Cases
15
10
0
0 20 40 60 80 100 120 140 160 180
Day s
Figure: N = 82.
Recovery Rate Model - Parameters
N = 21,083 a b σ ρ
Mean 5.03 0.5558 1.33 0.009232
Median 2.04 0.6183 0.23 0.008507
Std Dev 14.10 0.2778 5.97 0.001082
First Quartile 0.65 0.3052 0.047 0.000834
Third Quartile 4.28 0.7966 0.84 0.01319
Recovery Rate Model - Recovery Rates
0.7
Recovery Rate Estimates
0.65
0.6
0.55
0.5
0.45
0.4
0 50 100 150 200 250 300 350 400
Number of Days After Economic Default
Recovery Rate Model - Recovery Rates
RFV RT RMV
N = 69 EM KFM EM KFM EM KFM
Mean 0.4814 0.5068* 0.3919 0.4134* 0.8272 0.8868**
Median 0.4006 0.55 0.3204 0.4698 0.9 0.9299
StdDev 0.3029 0.2985 0.2442 0.2423 0.1780 0.1255
25 % 0.2 0.23 0.1578 0.1830 0.7267 0.8074
75 % 0.71 0.785 0.6020 0.6150 0.9577 0.9743
70
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29-Sep-2004 09-Aug-2005 19-Jun-2006 29-Apr-2007
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03-O ct-2004 30-Nov-2004 27-Jan-2005 26-Mar-2005
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series1
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30-Sep-2004 30-Jun-2005 30-Mar-2006 28-Dec-2006
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series1
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03-Apr-2005 22-Dec-2005 11-Sep-2006 01-Jun-2007