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Implied Default Probabilities and Losses Given Default from Option Prices

Author

Listed:
  • Jennifer Conrad
  • Robert F Dittmar
  • Allaudeen Hameed

Abstract

We propose a novel method of estimating default probabilities using equity options data. The resulting default probabilities are highly correlated with estimates of default probabilities extracted from CDS spreads, which assume constant losses given default. Additionally, the option-implied default probabilities are higher in bad economic times and for firms with poorer credit ratings and financial positions. A simple inferred measure of loss given default is related to underlying business conditions, and varies across sectors; the time series properties of this measure are similar after controlling for liquidity effects.

Suggested Citation

  • Jennifer Conrad & Robert F Dittmar & Allaudeen Hameed, 2020. "Implied Default Probabilities and Losses Given Default from Option Prices," Journal of Financial Econometrics, Oxford University Press, vol. 18(3), pages 629-652.
    • Handle: RePEc:oup:jfinec:v:18:y:2020:i:3:p:629-652.
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbaa017
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    Citations

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    Cited by:

    1. Florent Kanga GBONGUE & Lambert N’Galadjo BAMBA, 2023. "Le modèle hybride de la structure par terme des primes souveraines de crédit et de liquidité dans la zone UEMOA," Region et Developpement, Region et Developpement, LEAD, Universite du Sud - Toulon Var, vol. 57, pages 101-145.
    2. Malek Ben-Abdellatif & Hatem Ben-Ameur & Rim Chérif & Bruno Rémillard, 2024. "A two-factor structural model for valuing corporate securities," Review of Derivatives Research, Springer, vol. 27(2), pages 203-225, July.
    3. Ka Kei Chan & Ming‐Tsung Lin & Qinye Lu, 2024. "Corporate credit default swap systematic factors," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(7), pages 1224-1256, July.
    4. Pakorn Aschakulporn & Jin E. Zhang, 2022. "Bakshi, Kapadia, and Madan (2003) risk‐neutral moment estimators: An affine jump‐diffusion approach," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(3), pages 365-388, March.
    5. Jean‐François Bégin & Mathieu Boudreault & Mathieu Thériault, 2024. "Leveraging prices from credit and equity option markets for portfolio risk management," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(1), pages 122-147, January.

    More about this item

    Keywords

    contingent pricing; default probabilities; recovery rates;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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