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A robust method to retrieve option implied risk neutral densities for defaultable assets
Leduc, Guillaume Orosi, Gergely
Leduc, Guillaume
Orosi, Gergely
Date
2016
Authors
Advisor
Type
Peer-Reviewed
Article
Published version
Article
Published version
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Abstract
Risk neutral densities recovered from option prices can be used to infer market participants' expectations of future stock returns and are a vital tool for pricing illiquid exotic options. Although there is a broad literature on the subject, most studies do not address the likelihood of default. To fill this gap, in this paper we develop a novel method to retrieve the risk neutral probability density function from call options written on a defaultable asset. The primary advantage of the method is that default probabilities inferred by the model can be analytically expressed and, if available, can be incorporated as an input in a flexible, robust and easily implementable manner.