Firm-Specific Risk-Neutral Distributions with Options and CDS
Management Science
62 Pages Posted: 31 Jan 2017 Last revised: 18 Jun 2021
There are 2 versions of this paper
Firm-Specific Risk-Neutral Distributions with Options and CDS
Firm-Specific Risk-Neutral Distributions: The Role of CDS Spreads
Date Written: December 15, 2020
Abstract
We propose a method to extract the risk-neutral distribution of firm-specific stock returns using both options and credit default swaps (CDS). Options and CDS provide information about the central part and the left tail of the distribution, respectively. Taken together, but not in isolation, options and CDS span the intermediate part of the distribution, which is driven by exposure to the risk of large but not extreme returns. Through a series of asset-pricing tests, we show that this intermediate-return risk carries a premium, particularly at times of heightened market stress.
Keywords: Risk Neutral Distributions, Investor Expectations, CDS Spreads
JEL Classification: G12, G13, G14
Suggested Citation: Suggested Citation