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Probabilities of Default and the Market Price of Risk in a Distressed Economy, Miguel Segoviano, Raphael Espinoza

Abstract
We propose an original method to estimate the market price of risk under stress, which is needed to correct for risk aversion the CDS-implied probabilities of distress. The method is based, for simplicity, on a one-factor asset pricing model. The market price of risk under stress (the expectation of the market price of risk, conditional on it exceeding a certain threshold) is computed from the price of risk (which is the variance of the market price of risk) and the discount factor (which is the inverse of the expected market price of risk). The threshold is endogenously determined so that the probability of the price of risk exceeding it is also the probability of distress of the asset. The price of risk can be estimated via different methods, for instance derived from the VIX or from the factors in a Fama-MacBeth regression
Table Of Contents
Cover Page; Title Page; Copyright Page; Contents; I. Introduction; Figure 1. Ratio of CDS-implied Probability of Distress to Moody's KMV EDF; II. Theoretical Background; A. Risk-neutral Probabilities of Default and the Market Price of Risk; B. Conditional Expectation of the Market Price of Risk; C. Estimating the Price of Risk; III. Endogenous Threshold; Figure 2. Uniqueness of the Threshold; IV. Application to US Banks during the Crisis; Figure 3. Adjustment Factor and Market Price of Risk; Figure 4. Estimated Probabilities of Default; V. Conclusion; References; Footnotes
Language
eng
Literary Form
non fiction
Note
Description based upon print version of record
Physical Description
1 online resource (25 p.)
Specific Material Designation
remote
Form Of Item
online
Isbn
9781455224081

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