Bankruptcy Probabilities Inferred from Option Prices

Posted: 20 May 2019

See all articles by Stephen J. Taylor

Stephen J. Taylor

Lancaster University - Department of Accounting and Finance

Chi Feng Tzeng

National Tsing Hua University - College of Technology Management

Martin Widdicks

Lancaster University - Department of Accounting and Finance

Date Written: December 6, 2012

Abstract

Option prices contain forward looking information about stock price volatility and, potentially, the probability of bankruptcy. We develop a risk-neutral density (RND) model consisting of a mixture of two lognormal densities with a probability of bankruptcy. We calibrate this model to daily stock and option prices of six financial institutions during the onset of the financial crisis to see what information about bankruptcy probabilities can be inferred from option prices. The bankruptcy probability and the shape of the RND for the institutions are examined, particularly on major event dates. The empirical results show that acquiring banks have a lower bankruptcy probability than the acquired banks; RNDs of financial institutions reflect market shocks, especially in fat tails and bankruptcy probability. The results from multivariate regressions for each institution suggest that the small volatile firms, with low returns, have a higher chance of bankruptcy than large stable firms with high returns.

Keywords: Option prices, Bankruptcy probability, Risk-neutral density, Financial crisis

JEL Classification: G33

Suggested Citation

Taylor, Stephen J. and Tzeng, Chi Feng and Widdicks, Martin, Bankruptcy Probabilities Inferred from Option Prices (December 6, 2012). 25th Australasian Finance and Banking Conference 2012. Available at SSRN: https://ssrn.com/abstract=2135340 or http://dx.doi.org/10.2139/ssrn.2135340

Stephen J. Taylor

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom
+ 44 15 24 59 36 24 (Phone)
+ 44 15 24 84 73 21 (Fax)

HOME PAGE: http://www.lancs.ac.uk/staff/afasjt

Chi Feng Tzeng (Contact Author)

National Tsing Hua University - College of Technology Management ( email )

101, Section 2 Kuang Fu Road
Hsinchu, Taiwan 300
China

Martin Widdicks

Lancaster University - Department of Accounting and Finance ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

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