Recovery Rates in Investment-grade Pools of Credit Assets: A large deviations analysis

by Konstantinos Spiliopoulos of Brown University, and
Richard B. Sowers of University of Illinois at Urbana-Champaign

August 11, 2011

Abstract: We consider the effect of recovery rates on a pool of credit assets. We allow the recovery rate to depend on the defaults in a general way. Using the theory of large deviations, we study the structure of losses in a pool consisting of a continuum of types. We derive the corresponding rate function and show that it has a natural interpretation as the favored way to rearrange recoveries and losses among the different types. Numerical examples are also provided.

JEL Classification: G21, G33.

AMS Classification: 60F05, 60F10, 91G40.

Keywords: Recovery rates, Default rates, Credit assets, Large deviations.

Published in: Stochastic Processes and their Applications, Vol. 121, No. 12, (December 2011), pp. 2861-2898.

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