Bond prices, default probabilities and risk premiums

Hull, John C.; Predescu, Mirela; White, Alan

doi:10.21314/jcr.2005.007

Cited by 121 publications

(62 citation statements)

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“…Suppose we are pricing a simplified risky bond, both using the P-and Q-measure. It is known that parameters that define risk become larger (see for example [HPW05]) in the Q-measure, this is what we shall show next with the probability of default.…”

Section: Create Model For Payoffsupporting

confidence: 56%

Continuous Term Structures for Implied Recovery

Meibergen

2015

SSRN Journal

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Section: Create Model For Payoffsupporting

confidence: 56%

Continuous Term Structures for Implied Recovery

Meibergen

2015

SSRN Journal

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“…Using conversion factors from Hull et al (2005), we approximate physical PDs from the CDS implied risk-neutral PDs. We then use the Basel IRB formula and standard assumptions of LGD of 45% and 2.5 years maturity to compute risk weights for sovereign exposures from these PDs.…”

Section: Cds Implied Risk-weightsmentioning

confidence: 99%

The Zero Risk Fallacy? Banks' Sovereign Exposure and Sovereign Risk Spillovers

2017

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Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung des ZEW dar.Dis cus si on Papers are inten ded to make results of ZEW research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the ZEW. Abstract European banks are exposed to a substantial amount of risky sovereign debt. The "missing bank capital" resulting from the zero-risk weight exemption for European banks for European sovereign debt amplifies the co-movement between sovereign CDS spreads and facilitates cross-border financial-crisis spillovers. Risks spill over from risky periphery sovereigns to safer core countries, but not in the opposite direction nor for exposures to countries not exempted from risk-weighting. We consider the trade-off of benefits of sovereign debt (for banks and sovereigns) and spillover risk when applying risk-weights. More bank capital as well as positive risk-weighting for sovereign exposures mitigates spillovers.JEL classification: G01, G21, G28, G14, G15, F23

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“…Mathematically speaking, the risk-neutral probability is the probability measure under which the current market price of a generic contingent claim is equal to the discounted expected value of its future cash flows (Björk (1998)). The corresponding risk-neutral default probabilities are used for pricing because they build an extra return, called risk premium, to compensate market participants for the risk they are bearing (Hull et al (2005)). Historical default probabilities are probabilities calculated from historical data, and they are not used for pricing purposes.…”

Section: Financial Indicatorsmentioning

confidence: 99%

“…Following Hull et al (2005), we estimate for every rating class the one-year historical default probabilities, labeled DP P , from statistics on average cumulative global default yearly rates published by Moody's (Emery et al (2008)). In its annual reports, Moody's provides time-series of the yearly historical firms default probabilities grouped by rating classes.…”

Section: Building a Map Between Risk-neutral And Historical Probabilimentioning

confidence: 99%

Lévy Processes and the Financial Crisis: Can We Design a More Effective Deposit Protection?

Maccaferri¹,

Cariboni²,

Schoutens³

2012

International Journal of Financial Research

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Deposit Guarantee Schemes (DGSs) are institutions whose main aim is to provide a safety net for depositors. If a bank fails, depositors will recover their bank deposits up to a certain limit. During the recent financial crisis, DGSs were brought at the centre of the political and financial debate, especially due to the fact that the some DGSs resulted incapable to react to the crisis because of the lack of funds set aside. In this paper we propose to use Lévy processes to simulate the loss distribution of deposits insured by a DGS in case of banks' failure. The simulated distribution can be used to design an effective DGS. By simulating banks' default and the corresponding losses, our model allows defining a target level for the funds to be collected in order to promptly and effectively respond to financial turmoil and protect the citizens. The proposed approach is applied to a sample of Italian banks. Disclaimer:The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors and should not be attributed to the European Commission. Possible errors and omissions are those of the authors.

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Bond prices, default probabilities and risk premiums

Cited by 121 publications

References 0 publications

Continuous Term Structures for Implied Recovery

Continuous Term Structures for Implied Recovery

The Zero Risk Fallacy? Banks' Sovereign Exposure and Sovereign Risk Spillovers

Lévy Processes and the Financial Crisis: Can We Design a More Effective Deposit Protection?

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