Probabilities of Default and the Market Price of Risk in a Distressed Economy

WPIEA2011075 Image
Price:  $18.00

Author/Editor: Raphael A. Espinoza, Miguel A. Segoviano Basurto
Release Date: © April, 2011
ISBN : 978-1-45522-704-4
Stock #: WPIEA2011075
Stock Status: On back-order

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We propose an original method to estimate the market price of risk under stress, which is needed to correct for risk aversion the CDS-implied probabilities of distress. The method is based, for simplicity, on a one-factor asset pricing model. The market price of risk under stress (the expectation of the market price of risk, conditional on it exceeding a certain threshold) is computed from the price of risk (which is the variance of the market price of risk) and the discount factor (which is the inverse of the expected market price of risk). The threshold is endogenously determined so that the probability of the price of risk exceeding it is also the probability of distress of the asset. The price of risk can be estimated via different methods, for instance derived from the VIX or from the factors in a Fama-MacBeth regression.


Asset prices , Capital markets , Financial crisis , Financial institutions and markets , International financial system

More publications in this series: Working Papers

More publications by: Raphael A. Espinoza ; Miguel A. Segoviano Basurto