Robust Recovery Risk Hedging: Only the First Moment Matters
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چکیده
Credit derivatives are subject to at least two sources of risk: the default time and the recovery payment. This paper examines the impact of modeling the recovery payment on hedging strategies in a reduced-form model as well as a Merton-type model. We show that quadratic hedging approaches do only depend on the expected recovery payment at default and not the whole shape of the recovery payment distribution. This justifies assuming a certain recovery payment conditional on the default time. Hence, this result allows a simplified modeling of credit risk.
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