6533b7dbfe1ef96bd126fe47
RESEARCH PRODUCT
Robust Recovery Risk Hedging: Only the First Moment Matters
Monika MullerSiegfried Trautmannsubject
Credit default swap indexZero-coupon bondActuarial sciencemedia_common.quotation_subjectValue (economics)Credit eventEconometricsCredit derivativeBusinessPaymentInterest ratemedia_commonCredit riskdescription
Credit derivatives are subject to at least two sources of risk: the default time and the recovery payment. This paper examines the impact of modeling the recovery payment on hedging strategies in a reduced-form model as well as a structural model. We show that all hedging approaches based on a quadratic criterion do only depend on the expected recovery payment at default and not the whole shape of the recovery payment distribution if the underlying hedging instrument (say, a defaultable zero coupon bond) jumps to or reaches a pre-specified value when the credit event occurs. This justifies assuming a \emph{certain} recovery rate conditional on default time and interest rate level. Hence, this result allows a simplified modeling of credit risk.
| year | journal | country | edition | language |
|---|---|---|---|---|
| 2009-01-01 | SSRN Electronic Journal |