Contingent Claims and Hedging of Credit Risk with Equity Options
Davide E Avino,
Enrique Salvador
Abstract:Using contingent-claims valuation, we introduce novel hedge ratios for credit exposures using put options. Option hedge ratios are generally in line with the empirical sensitivities of credit spread changes to put option returns and, relative to stock hedge ratios, produce further reductions in volatility for a portfolio of North American firms. We show that option hedge ratios capture option-specific credit exposure related to the VIX index and the default spread, which is unaccounted for by Merton’s (1974) e… Show more
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