Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/241181 
Year of Publication: 
2020
Series/Report no.: 
Bank of Canada Staff Working Paper No. 2020-15
Publisher: 
Bank of Canada, Ottawa
Abstract: 
In this paper, we present a novel method to extract the risk-neutral probability of default of a firm from American put option prices. Building on the idea of a default corridor proposed in Carr and Wu (2011), we derive a parsimonious closed-form formula for American put option prices from which the probability of default can be inferred. The proposed method is easy to implement and helps overcome the main limitation of the method used in Carr and Wu (2011), which relies on the price of one deep-out-of-the-money put option. Our empirical results are based on seven large U.S. firms for the period 2002 to 2010. These results show that, in some cases, the option-implied probability of default can provide a more accurate estimate of default probability, compared to the estimates implied from credit default swap spreads.
Subjects: 
Asset pricing
Financial markets
Market structure and pricing
JEL: 
G
G1
G13
G3
G33
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

Files in This Item:
File
Size





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.