Updating the Option Implied Probability of Default Methodology

39 Pages Posted: 21 Jun 2016

See all articles by Johannes Vilsmeier

Johannes Vilsmeier

European Central Bank (ECB); Deutsche Bundesbank

Multiple version iconThere are 2 versions of this paper

Date Written: 2014

Abstract

In 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 produces arbitrary results and hence an alternative procedure is suggested that is based on the Lagrange multipliers. Based on numerical evaluations and an illustrative empirical application we conclude that the framework provides very promising results.

Keywords: Option Implied Probability of Default, Risk Neutral Density, Cross Entropy

JEL Classification: C51, C52, C61, G12, G24, G32

Suggested Citation

Vilsmeier, Johannes, Updating the Option Implied Probability of Default Methodology (2014). Bundesbank Discussion Paper No. 43/2014, Available at SSRN: https://ssrn.com/abstract=2797025 or http://dx.doi.org/10.2139/ssrn.2797025

Johannes Vilsmeier (Contact Author)

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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