Using equity options to imply credit information

Angie Elkhodiry (), Joseph Paradi and Luis Seco

Annals of Operations Research, 2011, vol. 185, issue 1, 45-73

Abstract: The evolution of credit derivatives has inspired many researchers to investigate the behaviour of credit spreads. Today the growing consensus is that the equity option market provides sufficient information to estimate latent credit parameters. Hull et al. (J. Credit Risk 1(1):3–28, 2005 ) propose a clever approach to estimate credit spreads from the equity option market. In this paper we first perform a time series analysis to test the conjecture of an existing relationship between credit spreads and implied equity volatility and find strong evidence of a positive relationship. We also propose an extension to Hull et al.’s paper that significantly improves credit spread estimation. Copyright Springer Science+Business Media, LLC 2011

Keywords: Credit spreads; Implied volatility; Merton’s model; Liquidity; First-passage; Default probability (search for similar items in EconPapers)
Date: 2011
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DOI: 10.1007/s10479-009-0627-z

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