Typically, implied volatilities for defaultable instruments are not available in the financial market since quotations related to options on defaultable bonds or on credit default swaps are usually not quoted by brokers. However, an estimate of their volatilities is needed for pricing purposes. In this paper, we provide a methodology to infer market implied volatilities for defaultable bonds using equity implied volatilities and CDS spreads quoted by the market in relation to a specific issuer. The theoretical framework we propose is based on the Merton’s model under stochastic interest rates where the short rate is assumed to follow the Hull–White model. A numerical analysis is provided to illustrate the calibration process to be performed starting from financial market data. The market implied volatility calibrated according to the proposed methodology could be used to evaluate options where the underlying is a risky bond, i.e. callable bond or other types of credit-risk sensitive financial instruments.

(2019). Market implied volatilities for defaultable bonds [journal article - articolo]. In ANNALS OF OPERATIONS RESEARCH. Retrieved from http://hdl.handle.net/10446/128768

Market implied volatilities for defaultable bonds

Russo, Vincenzo;Giacometti, Rosella;
2019-01-01

Abstract

Typically, implied volatilities for defaultable instruments are not available in the financial market since quotations related to options on defaultable bonds or on credit default swaps are usually not quoted by brokers. However, an estimate of their volatilities is needed for pricing purposes. In this paper, we provide a methodology to infer market implied volatilities for defaultable bonds using equity implied volatilities and CDS spreads quoted by the market in relation to a specific issuer. The theoretical framework we propose is based on the Merton’s model under stochastic interest rates where the short rate is assumed to follow the Hull–White model. A numerical analysis is provided to illustrate the calibration process to be performed starting from financial market data. The market implied volatility calibrated according to the proposed methodology could be used to evaluate options where the underlying is a risky bond, i.e. callable bond or other types of credit-risk sensitive financial instruments.
articolo
2019
Russo, Vincenzo; Giacometti, Rosella; Fabozzi, Frank J.
(2019). Market implied volatilities for defaultable bonds [journal article - articolo]. In ANNALS OF OPERATIONS RESEARCH. Retrieved from http://hdl.handle.net/10446/128768
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/10446/128768
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