IDEAS home Printed from
   My bibliography  Save this paper

Probabilities of Default and the Market Price of Risk in a Distressed Economy


  • Miguel A. Segoviano Basurto
  • Raphael A Espinoza


We propose an original method to estimate the market price of risk under stress, which is needed to correct for risk aversion the CDS-implied probabilities of distress. The method is based, for simplicity, on a one-factor asset pricing model. The market price of risk under stress (the expectation of the market price of risk, conditional on it exceeding a certain threshold) is computed from the price of risk (which is the variance of the market price of risk) and the discount factor (which is the inverse of the expected market price of risk). The threshold is endogenously determined so that the probability of the price of risk exceeding it is also the probability of distress of the asset. The price of risk can be estimated via different methods, for instance derived from the VIX or from the factors in a Fama-MacBeth regression.

Suggested Citation

  • Miguel A. Segoviano Basurto & Raphael A Espinoza, 2011. "Probabilities of Default and the Market Price of Risk in a Distressed Economy," IMF Working Papers 11/75, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:11/75

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Adrian, Tobias & Etula, Erkko & Shin, Hyun Song, 2009. "Risk appetite and exchange Rates," Staff Reports 361, Federal Reserve Bank of New York, revised 10 Dec 2015.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Carlos Caceres & D. Filiz Unsal, 2013. "Sovereign Spreads and Contagion Risks in Asia," Asian Economic Journal, East Asian Economic Association, vol. 27(3), pages 219-243, September.
    2. Florence Bouvet & Ryan Brady & Sharmila King, 2013. "Debt Contagion in Europe: A Panel-VAR Analysis," Departmental Working Papers 44, United States Naval Academy Department of Economics.
    3. repec:gam:jjrfmx:v:10:y:2017:i:2:p:8-:d:95645 is not listed on IDEAS
    4. González-Hermosillo, Brenda & Johnson, Christian, 2017. "Transmission of financial stress in Europe: The pivotal role of Italy and Spain, but not Greece," Journal of Economics and Business, Elsevier, vol. 90(C), pages 49-64.
    5. Frigyes F Heinz & Yan M Sun, 2014. "Sovereign CDS Spreads in Europe; The Role of Global Risk Aversion, Economic Fundamentals, Liquidity, and Spillovers," IMF Working Papers 14/17, International Monetary Fund.
    6. International Monetary Fund, 2014. "Switzerland; Technical Note-Systemic Risk and Contagion Analysis," IMF Staff Country Reports 14/268, International Monetary Fund.
    7. Gastón Andrés Giordana & Ingmar Schumacher, 2017. "An Empirical Study on the Impact of Basel III Standards on Banks’ Default Risk: The Case of Luxembourg," Journal of Risk and Financial Management, MDPI, Open Access Journal, vol. 10(2), pages 1-21, April.
    8. Florence Bouvet & Ryan Brady & Sharmila King, 2013. "Debt Contagion in Europe: A Panel-Vector Autoregressive (VAR) Analysis," Social Sciences, MDPI, Open Access Journal, vol. 2(4), pages 1-23, December.
    9. Miguel A. Segoviano Basurto & Carlos Caceres & Vincenzo Guzzo, 2010. "Sovereign Spreads; Global Risk Aversion, Contagion or Fundamentals?," IMF Working Papers 10/120, International Monetary Fund.

    More about this item


    Credit default swap; Price of risk; CDS; risk-neutral probability; probability; probabilities; equation; probability of default; conditional expectation;

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:imf:imfwpa:11/75. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jim Beardow) or (Hassan Zaidi). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.