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 around various types of default events. Our detailed and unique study of the trading microstructure allows us to assess bond liquidity at different stages following default. 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. We quantify the relation between these recovery rates and a comprehensive set of bond characteristics, firm fundamentals, macroeconomic variables and liquidity measures, explaining 66 % of the cross-sectional variation in recovery rates. These results reveal that transaction cost metrics of liquidity are particularly important determinants of the recovery rate, along with bond covenants, balance sheet ratios motivated by structural credit risk models, and macroeconomic variables. Additionally, w