From bid-ask credit default swap quotes to risk-neutral default probabilities using distorted expectations

Matteo Michielon, Asma Khedher and Peter Spreij

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Abstract: Risk-neutral default probabilities can be implied from credit default swap (CDS) market quotes. In practice, mid CDS quotes are used as inputs, as their risk-neutral counterparts are not observable. We show how to imply risk-neutral default probabilities from bid and ask quotes directly by means of formulating the CDS calibration problem to bid and ask market quotes within the conic finance framework. Assuming the risk-neutral distribution of the default time to be driven by a Poisson process we prove, under mild liquidity-related assumptions, that the calibration problem admits a unique solution that also allows to jointly calculate the implied liquidity of the market.

Date: 2021-08
New Economics Papers: this item is included in nep-isf and nep-rmg
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Published in journal={International Journal of Theoretical and Applied Finance}, volume={24}, number={3} journal={International Journal of Theoretical and Applied Finance}, volume={24}, number={3}, year={2021}

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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2108.06578

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