Explaining the Level of Credit Spreads: Option-Implied Jump Risk Premia in a Firm Value Model

Posted: 19 Sep 2008

See all articles by Martijn Cremers

Martijn Cremers

University of Notre Dame; ECGI

Joost Driessen

Tilburg University - Tilburg University School of Economics and Management; Tilburg University - Center for Economic Research (CentER)

Pascal J. Maenhout

INSEAD - Finance

Multiple version iconThere are 3 versions of this paper

Date Written: September 2008

Abstract

We study whether option-implied jump risk premia can explain the high observed level of credit spreads. We use a structural jump-diffusion firm value model to assess the level of credit spreads generated by option-implied jump risk premia. Prices and returns of equity index and individual options are used to estimate the jump parameters. We further calibrate the model to historical information on default risk and the equity premium. The results show that incorporating option-implied jump risk premia brings predicted credit spread levels much closer to observed levels. The introduction of jumps also helps to improve the fit of the volatility of credit spreads and equity returns.

Keywords: G12, G13

Suggested Citation

Cremers, K. J. Martijn and Driessen, Joost and Maenhout, Pascal J., Explaining the Level of Credit Spreads: Option-Implied Jump Risk Premia in a Firm Value Model (September 2008). The Review of Financial Studies, Vol. 21, Issue 5, pp. 2209-2242, 2008, Available at SSRN: https://ssrn.com/abstract=1270464 or http://dx.doi.org/hhn071

K. J. Martijn Cremers (Contact Author)

University of Notre Dame ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

ECGI ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Joost Driessen

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Pascal J. Maenhout

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France

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