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Pricing the risks of default. (English) Zbl 1274.91426

Summary: This paper decomposes default risk into timing and recovery risks. The two default components are explicitly priced as if they were traded in the futures market. We develop estimation strategies evaluating recovery risks and then construct implicit prices of contingent securities reflecting purely the timing risk. The models are estimated on monthly data for rates on certificates of deposit offered by institutions in the savings and loan industry, during the 1987–1991 period. Empirical results support market expectations of lower likelihoods of default after 1989.

MSC:

91G20 Derivative securities (option pricing, hedging, etc.)
91G40 Credit risk
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