Measuring Option Implied Degree of Distress in the Us Financial Sector Using the Entropy Principle

68 Pages Posted: 21 Jun 2016

See all articles by Philipp Matros

Philipp Matros

University of Regensburg

Johannes Vilsmeier

European Central Bank (ECB); Deutsche Bundesbank

Date Written: 2012

Abstract

We estimate time series of option implied Probabilities of Default (PoDs) for 19 major US financial institutions from 2002 to 2012. These PoDs are estimated as mass points of entropy based risk neutral densities and subsequently corrected for maturity dependence. The obtained time series are evaluated with regard to their consistency and predictive power and their properties are compared to Credit Default Swap Spreads (CDS). Moreover, we also derive an indicator for the systemic risk in the US financial sector. We find that the PoDs are superior to CDS in identifying the high risk banks prior to the Lehman crisis.

Keywords: Entropy Principle, Risk Neutral Density, Probability of Default, Financial Stability Indicator, Credit Default Swaps

JEL Classification: C14, C32, G01, G21

Suggested Citation

Matros, Philipp and Vilsmeier, Johannes, Measuring Option Implied Degree of Distress in the Us Financial Sector Using the Entropy Principle (2012). Bundesbank Discussion Paper No. 30/2012, Available at SSRN: https://ssrn.com/abstract=2796890 or http://dx.doi.org/10.2139/ssrn.2796890

Philipp Matros (Contact Author)

University of Regensburg ( email )

93040 Regensburg
D-93040 Regensburg, 93053
Germany

Johannes Vilsmeier

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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