TL;DR
This paper establishes a no-arbitrage relationship between recovery swap rates, default swap spreads, and CDS spreads, highlighting that the fair forward recovery rate includes a convexity premium over the expected recovery value.
Contribution
It introduces a theoretical framework linking recovery swaps with other credit derivatives and emphasizes the convexity premium in the fair recovery rate.
Findings
Derived arbitrage-free relationship between recovery swaps and other credit spreads.
Showed that the fair forward recovery rate includes a convexity premium.
Provided insights into recovery rate modeling and pricing.
Abstract
We derive an arbitrage free relationship between recovery swap rates, digital default swap spreads and conventional CDS spreads, and argue that the fair forward recovery rate used in recovery swaps must contain a convexity premium over the expected recovery value.
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Taxonomy
TopicsPsychiatric care and mental health services