Explaining the level of credit spreads

Option-implied jump risk premia in a firm value model

Martijn Cremers, Joost Driessen, Pascal Maenhout

Research output: Contribution to journalArticleScientificpeer-review

Abstract

We study whether option-implied jump risk premia can explain the high observed level of credit spreads. We use a structural jump-diffusion firm value model to assess the level of credit spreads generated by option-implied jump risk premia. Prices and returns of equity index and individual options are used to estimate the jump parameters. We further calibrate the model to historical information on default risk and the equity premium. The results show that incorporating option-implied jump risk premia brings predicted credit spread levels much closer to observed levels. The introduction of jumps also helps to improve the fit of the volatility of credit spreads and equity returns.
Original languageEnglish
Pages (from-to)2209-2242
JournalThe Review of Financial Studies
Volume21
Issue number5
DOIs
Publication statusPublished - 1 Sep 2008
Externally publishedYes

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Jump risk
Credit spreads
Spread options
Firm value
Risk premia
Jump
Equity returns
Equity
Equity premium
Default risk
Jump diffusion

Cite this

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Explaining the level of credit spreads : Option-implied jump risk premia in a firm value model. / Cremers, Martijn; Driessen, Joost; Maenhout, Pascal.

In: The Review of Financial Studies, Vol. 21, No. 5, 01.09.2008, p. 2209-2242.

Research output: Contribution to journalArticleScientificpeer-review

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