The Determinants of Recovery Rates in the US Corporate Bond Market

We examine the recovery rates of defaulted bonds in the US corporate bond market over the time period from 2002 to 2010, based on a complete set of traded prices and volumes. A detailed study of the microstructure of trading in defaulted bonds around various types of default events is provided. We document temporary price pressure with high trading volumes on the default day and the following 30 days, and low trading activity at pre-default levels thereafter. Based on these observations, market-based recovery rates in the period representing the high trading activity window are estimated. As an important additional contribution, we quantify the liquidity of defaulted bonds using various liquidity measures. We explore the relation between the recovery rates and these measures, considering additionally a comprehensive set of bond characteristics, firm fundamentals and macroeconomic variables. Our analysis explains 66% of the cross-sectional variation in recovery rates, revealing that transaction cost metrics of liquidity are particularly important variables, along with bond covenants, balance sheet ratios motivated by structural credit risk models, and macroeconomic variables. Additionally, we study the relation between price and liquidity changes in different post-default time periods