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Pricing credit risk through equity options calibration

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  • Marco Fabio Delzio

Abstract

Purpose - To implement the model described in the companion paper, “Pricing credit risk through equity options calibration, part 1 – theory,” and show how to calculate the price of a set of coupon bonds issued by a US telecommunications and media company, AOL Time Warner, based on the information retrieved by the AOL equity derivatives market. Design/methodology/approach - The risk‐neutral density function of AOL Time Warner's stock is inferred from options volatilities; from there, the AOL assets risk neutral density function is calculated together with the default probabilities at different dates in the future. Finally, a set of AOL coupon bonds are priced accordingly and compared to market prices. Findings - The AOL model‐theoretical prices are close to market prices, meaning that it is possible to perform relative‐value analysis in the risky bonds market based on the equity markets information. Originality/value - The paper shows how easily the model can be used as a tool for performing relative‐value analysis between the equity options and the credit markets by using real market data.

Suggested Citation

  • Marco Fabio Delzio, 2006. "Pricing credit risk through equity options calibration," Journal of Risk Finance, Emerald Group Publishing Limited, vol. 7(4), pages 386-401, August.
    • Handle: RePEc:eme:jrfpps:15265940610692626
    DOI: 10.1108/15265940610692626
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