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This study empirically analyses the historical performance of defaulted debt from Moody's Ultimate Recovery Database (1987�2010). Motivated by a stylized structural model of credit risk with systematic recovery risk, we argue and find evidence that returns on defaulted debt co-vary with determinants of the market risk premium, firm specific and structural factors. Defaulted debt returns in our sample are observed to be increasing in collateral quality or debt cushion of the issue. Returns are also increasing for issuers having superior ratings at origination, more leverage at default, higher cumulative abnormal returns on equity prior to default, or greater market implied loss severity at default. Considering systematic factors, returns on defaulted debt are positively related to equity market indices and industry default rates. On the other hand, defaulted debt returns decrease with short-term interest rates. In a rolling out-of-time and out-of-sample re-sampling experiment we show that our leading model exhibits superior performance. We also document the economic significance of these results through excess abnormal returns, implementing a hypothetical trading strategy, of around 5%�6% (2%�3%) assuming zero (1 bp per month) round-trip transaction costs. These results are of practical relevance to investors and risk managers in this segment of the fixed income market.
