Explaining the Level of Credit Spreads: Option-Implied Jump Risk Premia in a Firm Value Model
AbstractWe study whether option-implied jump risk premia can explain the high observed level of credit spreads. We use a structural jump-diffusion firm value model to assess the level of credit spreads generated by option-implied jump risk premia. Prices and returns of equity index and individual options are used to estimate the jump parameters. We further calibrate the model to historical information on default risk and the equity premium. The results show that incorporating option-implied jump risk premia brings predicted credit spread levels much closer to observed levels. The introduction of jumps also helps to improve the fit of the volatility of credit spreads and equity returns. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: email@example.com, Oxford University Press.
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Bibliographic InfoArticle provided by Society for Financial Studies in its journal The Review of Financial Studies.
Volume (Year): 21 (2008)
Issue (Month): 5 (September)
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Other versions of this item:
- Martijn Cremers & Joost Driessen & Pascal Maenhout & David Weinbaum, 2005. "Explaining the level of credit spreads: option-implied jump risk premia in a firm value model," BIS Working Papers 191, Bank for International Settlements.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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