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Bankruptcy probabilities inferred from option prices

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Bankruptcy probabilities inferred from option prices. / Taylor, Stephen J.; Tzeng, Chi-Feng; Widdicks, Martin.

In: Journal of Derivatives, Vol. 22, No. 2, 2014, p. 8-31.

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Taylor, Stephen J. ; Tzeng, Chi-Feng ; Widdicks, Martin. / Bankruptcy probabilities inferred from option prices. In: Journal of Derivatives. 2014 ; Vol. 22, No. 2. pp. 8-31.

Bibtex

@article{411ebf3070a14735ac922663acd28c5e,
title = "Bankruptcy probabilities inferred from option prices",
abstract = "Option prices contain forward looking information about stock price volatility and, potentially, the probability of default. We develop a risk-neutral density (RND) model consisting of a mixture of two lognormal densities augmented with a probability of bankruptcy. To test the model we calibrate it to daily stock and option prices of six financial institutions during the onset of the 2008 financial crisis. We find that the addition of the probability of bankruptcy term substantially improves the quality of the fit of the RND. The bankruptcy probability and the shape of the RND for the institutions are examined, particularly on major event dates. We show that acquiring banks have lower bankruptcy probabilities than the acquired banks and that the RNDs of financial institutions reflect market shocks, especially through the implied bankruptcy probabilities.",
keywords = "Option prices, Bankruptcy probability, Risk-neutral density, Financial crisis",
author = "Taylor, {Stephen J.} and Chi-Feng Tzeng and Martin Widdicks",
note = "Accepted by journal editor 2014.",
year = "2014",
doi = "10.3905/jod.2014.22.2.008",
language = "English",
volume = "22",
pages = "8--31",
journal = "Journal of Derivatives",
issn = "1074-1240",
publisher = "Institutional Investor, Inc",
number = "2",

}

RIS

TY - JOUR

T1 - Bankruptcy probabilities inferred from option prices

AU - Taylor, Stephen J.

AU - Tzeng, Chi-Feng

AU - Widdicks, Martin

N1 - Accepted by journal editor 2014.

PY - 2014

Y1 - 2014

N2 - Option prices contain forward looking information about stock price volatility and, potentially, the probability of default. We develop a risk-neutral density (RND) model consisting of a mixture of two lognormal densities augmented with a probability of bankruptcy. To test the model we calibrate it to daily stock and option prices of six financial institutions during the onset of the 2008 financial crisis. We find that the addition of the probability of bankruptcy term substantially improves the quality of the fit of the RND. The bankruptcy probability and the shape of the RND for the institutions are examined, particularly on major event dates. We show that acquiring banks have lower bankruptcy probabilities than the acquired banks and that the RNDs of financial institutions reflect market shocks, especially through the implied bankruptcy probabilities.

AB - Option prices contain forward looking information about stock price volatility and, potentially, the probability of default. We develop a risk-neutral density (RND) model consisting of a mixture of two lognormal densities augmented with a probability of bankruptcy. To test the model we calibrate it to daily stock and option prices of six financial institutions during the onset of the 2008 financial crisis. We find that the addition of the probability of bankruptcy term substantially improves the quality of the fit of the RND. The bankruptcy probability and the shape of the RND for the institutions are examined, particularly on major event dates. We show that acquiring banks have lower bankruptcy probabilities than the acquired banks and that the RNDs of financial institutions reflect market shocks, especially through the implied bankruptcy probabilities.

KW - Option prices

KW - Bankruptcy probability

KW - Risk-neutral density

KW - Financial crisis

U2 - 10.3905/jod.2014.22.2.008

DO - 10.3905/jod.2014.22.2.008

M3 - Journal article

VL - 22

SP - 8

EP - 31

JO - Journal of Derivatives

JF - Journal of Derivatives

SN - 1074-1240

IS - 2

ER -