Option-Based Credit Spreads

Culp, Christopher L.; Nozawa, Yoshio; Veronesi, Pietro

doi:10.1257/aer.20151606

Cited by 81 publications

(19 citation statements)

References 39 publications

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“…Kelly et al (2016) study the US …nancial-sector tail risk during the 2007-2009 crisis from the price of out-of-themoney puts. Culp et al (2018) empirically extend Merton's put insights. Siriwardane (2019) uses Carr and Wu's default corridor to infer credit-risk spreads.…”

Section: Related Literaturementioning

confidence: 56%

European Puts, Credit Protection, and Endogenous Default

Rodríguez

2020

Quart. J. of Fin.

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In a default corridor [Formula: see text] that the stock price can never enter, a deep out-of-the-money American put option replicates a pure credit contract (Carr and Wu, 2011, A Simple Robust Link between American Puts and Credit Protection, Review of Financial Studies 24, 473–505). Assuming discrete (one-period-ahead predictable) cash flows, we show that an endogenous credit-risk model generates, along with the default event, a default corridor at the cash-outflow dates, where [Formula: see text] is given by these outflows (i.e., debt service and negative earnings minus dividends). In this endogenous setting, however, the put replicating the credit contract is not American, but European. Specifically, the crucial assumption that determines an endogenous default corridor at the cash-outflow dates is that equityholders’ deep pockets absorb these outflows; that is, no equityholders’ fresh money, no endogenous corridor.

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Section: Related Literaturementioning

confidence: 56%

European Puts, Credit Protection, and Endogenous Default

Rodríguez

2020

Quart. J. of Fin.

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“…Our work also relates to recent research that uses data from options markets to understand credit risk and bank risk. Culp, Nozawa, and Veronesi (2014) construct pseudo firms that have traded securities as assets (e.g., a stock index) and pseudo bonds-a combination of Treasuries and put options-as liabilities. In one of their applications, they also consider a bank that owns a portfolio of pseudo bonds.…”

Section: Introductionmentioning

confidence: 99%

Bank Risk Dynamics and Distance to Default

Nagel

Purnanandam

2019

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We adapt structural models of default risk to take into account the special nature of bank assets. The usual assumption of log-normally distributed asset values is not appropriate for banks. Typical bank assets are risky debt claims, which implies that they embed a short put option on the borrowers' assets, leading to a concave payoff. This has important consequences for banks' risk dynamics and distance to default estimation. Due to the payoff non-linearity, bank asset volatility rises following negative shocks to borrower asset values. As a result, standard structural models in which the asset volatility is assumed to be constant can severely understate banks' default risk in good times when asset values are high. Bank equity payoffs resemble a mezzanine claim rather than a call option. Bank equity return volatility is therefore much more sensitive to big negative shocks to asset values than in standard structural models.

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“…5 See, e.g., Elton, Gruber, Agrawal, and Mann (2001), Longstaff, Mithal, and Neis (2005), Chen, Lesmond, and Wei (2007), Feldhütter and Schaefer (2018), and Culp, Nozawa, and Veronesi (2018).…”

Section: Introductionmentioning

confidence: 99%

Asymmetric Information, Dynamic Debt Issuance, and the Term Structure of Credit Spreads

2019

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We propose a tractable model of a firm's dynamic debt and equity issuance policies in the presence of asymmetric information. Because "investment-grade" firms can access debt markets, managers who observe a bad private signal can both conceal this information and shield shareholders from infusing capital into the firm by issuing new debt to service existing debt, thus avoiding default. The implication is that the "asymmetric information channel" can generate jumps to default (from the creditors' perspective) only for those "high-yield" firms that have exhausted their ability to borrow. Thus, our model deepens the "credit spread puzzle" for investment-grade firms.

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Option-Based Credit Spreads

Cited by 81 publications

References 39 publications

European Puts, Credit Protection, and Endogenous Default

European Puts, Credit Protection, and Endogenous Default

Bank Risk Dynamics and Distance to Default

Asymmetric Information, Dynamic Debt Issuance, and the Term Structure of Credit Spreads

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