The role of correlation

Risk analysis


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 appears to be non-linear, with RR dropping rapidly from around 55% when DR is in the range of 1.0% to 1.5

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