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

62 Pages Posted: 7 Sep 2017

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

John W. Schindler

Board of Governors of the Federal Reserve System

Samuel Rosen

Temple University, Fox School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: 2017-08-31

Abstract

We propose a method to extract individual firms' risk-neutral return distributions 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, options and CDS span the intermediate part of the distribution, which is driven by moderate-sized jump risk. We study the returns on a trading strategy that buys (sells) stocks exposed to positive (negative) moderate-sized jump risk unspanned by options or CDS individually. Controlling for many known factors, this strategy earns a 0.5% premium per month, highlighting the economic value of combining options and CDS.

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 Schindler, John W. and Rosen, Samuel, Firm-Specific Risk-Neutral Distributions: The Role of CDS Spreads (2017-08-31). FRB International Finance Discussion Paper No. 1212. Available at SSRN: https://ssrn.com/abstract=3031145 or http://dx.doi.org/10.17016/IFDP.2017.1212

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/

John W. Schindler

Board of Governors of the Federal Reserve System ( email )

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

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/

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