Updating the Option Implied Probability of Default Methodology
AbstractIn this paper we ‘update’ the option implied probability of default (option 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 has some serious drawbacks and hence an alternative procedure is suggested that is based on the Lagrange multipliers. Carrying out numerical evaluations and a practical application we find that the framework provides very promising results.
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Bibliographic InfoPaper provided by University of Regensburg, Department of Economics in its series University of Regensburg Working Papers in Business, Economics and Management Information Systems with number 462.
Date of creation: 12 Oct 2011
Date of revision:
Option Implied Probability of Default; Risk Neutral Density; Cross Entropy;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-10-22 (All new papers)
- NEP-BAN-2011-10-22 (Banking)
- NEP-CIS-2011-10-22 (Confederation of Independent States)
- NEP-RMG-2011-10-22 (Risk Management)
- NEP-UPT-2011-10-22 (Utility Models & Prospect Theory)
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