Pricing Recovery - Evidence from Markets, CDS Auctions and Ultimate Recovery

I examine pricing of credit securities after a credit event for a sample of rms on which CDS are traded. Secondary market prices of bonds along with those discovered at Credit Event Auctions are estimates of terminal or ultimate recovery on these securities. I use hand-collected data on ultimate recovery to jointly test for bias in prices at the auction and in secondary markets. I find that ultimate recovery is mispriced. Credit Event Auctions are biased in a manner consistent with theory and generate prices that, on average, underestimate ultimate recovery resulting in higher payouts to credit protection buyers. Moreover, bond prices in secondary markets are more informed about ultimate recovery before the auction than after it suggesting that existence of open CDS positions enriches the information environment for these bonds.