Recovery Risk in Credit Default Swap Premia

Dr. Timo Schläfer completed his doctoral thesis under the supervision of Prof. Dr. Marliese Uhrig-Homburg at the Chair of Financial Engineering and Derivatives at the Karlsruhe Institute of Technology. He works in the investment banking industry.

The finance literature looks at a number of factors to explain risk premia in corporate debt, such as liquidity effects, jump-to-default risk, and contagion risk. Stochastic recovery rates as a source of systematic risk have not received much attention so far, most likely due to the difficulties around decomposing the expected loss. Timo Schläfer exploits the fact that differently-ranking debt instruments of the same issuer face identical default risk but different default-conditional recovery rates. He shows that this allows isolating recovery risk without any of the rigid assumptions employed by priors and implements his approach using credit default swap data.