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I am trying to determine the effect of recovery rate on the Kth-to-default CDS Basket made up of 5 names (all major investment bank names). I repeatedly change the recovery rate assumption from 0 to 1.0 on the Markit provided spreads when building my credit curve and re-value the fair spread on kth-to-default basket. If I plot the fair spread vs recovery rate, I get something like below.

enter image description here

I can probably explain the plot for first-to-default (k=1). As the RR increases, the protection seller has less to pay in case of first default, so the spread decreases (?) However, I am struggling to explain the apparent no effect of RR on second and third to default.

Would like to get your opinion on if this plot looks good to you? Any idea how it can be explained?

Thank you for your time.

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  • $\begingroup$ Are you interpreting the CDS quotes correctly? quant.stackexchange.com/questions/74644 $\endgroup$
    – Dimitri Vulis
    Jul 13 at 21:31
  • $\begingroup$ I think I am. I have the CDS quoted spreads from markit which are the running coupons (not the standardized coupons) for various maturities and that's what I used in building my credit curve. I can correctly recover the spreads from my built curve. $\endgroup$
    – Yoshiro
    Jul 13 at 21:57
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    $\begingroup$ It actually sounds that you don't. $\endgroup$
    – Dimitri Vulis
    Jul 14 at 1:22
  • $\begingroup$ Do you mind elaborating a little what could be wrong in my interpretation ? Is there something in the above plot that suggests it ? Thank you. $\endgroup$
    – Yoshiro
    Jul 14 at 12:12

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