The role of correlation
In this second column on the potential pro-cyclicality of Basel II, David Rowe surveys recent research on the role of correlation between probability of default and recovery rates, as well as among default probabilities
There is a strong intuition that default rates (DR) and recovery rates (RR) will exhibit a negative correlation over time. In their July 2002 BIS working paper, Altman, Resti & Sironi examined this question using annual US non-investment-grade bond market data from 1982 through 2000.1 On a univariate basis, they found clear empirical evidence for such a negative correlation. The relationship
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