Updating the option implied probability of default methodology

ABSTRACT In this paper, we update the option implied probability of default (iPoD) approach recently suggested in the literature. First, a numerically more stable objective function for the estimation of the risk-neutral density is derived, whose integrals can be solved analytically. Second, it is reasoned that the originally proposed approach for the estimation of the PoD produces arbitrary results; hence, an alternative procedure-based on the Lagrange multipliers - is suggested. Based on numerical evaluations and an illustrative empirical application, we conclude that the framework provides very promising results.