Firm-Specific Risk-Neutral Distributions: The Role of CDS Spreads

67 Pages Posted: 31 Jan 2017 Last revised: 20 May 2019

See all articles by Sirio Aramonte

Sirio Aramonte

Bank for International Settlements (BIS)

Mohammad R. Jahan-Parvar

Board of Governors of the Federal Reserve System

Samuel Rosen

Temple University, Fox School of Business

John W. Schindler

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: October 30, 2018

Abstract

We propose a method to extract the risk-neutral distribution of firm-specific stock returns by combining options and credit default swaps (CDS). Options provide information about the central part of the distribution, and CDS anchor the left tail. Jointly, but not in isolation, options and CDS span the intermediate part of the distribution, which is driven by exposure to the risk of large but not extreme returns. We study the returns on a trading strategy buying (selling) stocks that are more (less) exposed to such risk. Controlling for many known factors, this strategy earns a 0.5% premium per month. The results are robust to using CDS of different maturities.

Keywords: Risk neutral distributions, CDS spreads, Cross-section of expected returns

JEL Classification: G12, G13, G14

Suggested Citation

Aramonte, Sirio and Jahan-Parvar, Mohammad R. and Rosen, Samuel and Schindler, John W., Firm-Specific Risk-Neutral Distributions: The Role of CDS Spreads (October 30, 2018). Available at SSRN: https://ssrn.com/abstract=2908524 or http://dx.doi.org/10.2139/ssrn.2908524

Sirio Aramonte (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Mohammad R. Jahan-Parvar

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://sites.google.com/site/mrjahan/

Samuel Rosen

Temple University, Fox School of Business ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States

HOME PAGE: http://sites.google.com/view/samuel-rosen/

John W. Schindler

Board of Governors of the Federal Reserve System ( email )

Washington, DC 20551
United States
202-452-3889 (Phone)

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