What is the value of modified restructuring?

Alex Reyfman and Klaus Toft

In this chapter, we present a framework for quantifying the value of modified restructuring (Mod R), modified modified restructuring (Mod Mod R), and old restructuring (Old R) in a credit default swap (CDS) contract, relative to a contract with only bankruptcy and failure to pay credit events (No R).11Under our base-case assumptions, for a five-year CDS contract, the value of Mod R is 1.9% of the No R spread, the value of Mod Mod R is 2.5%, and the value of Old R is 10.1%. We find that for reasonable parameter values, the model produces a Mod R premium of 1–6% of the No R spread for a five-year 100 basis points (bps) CDS, which is at odds with the current market premium of 5–10% at the time of writing. This suggests that market participants may be overpaying for the cheapest-to-deliver option in Mod R contracts.

The value of the restructuring credit event in a CDS contract depends upon:

  • the contractual maturity restrictions on deliverable obligations;

  • the term of the CDS contract;

  • the capital structure of the reference entity; and

  • the likelihood of the restructuring credit event relative to bankruptcy or failure to pay.

The Mod R CDS contract places the most

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