Ex Ante Risk in the Corporate Bond Market: Evidence from Synthetic Options

61 Pages Posted: 25 Mar 2019 Last revised: 17 Aug 2019

See all articles by Steven Shu-Hsiu Chen

Steven Shu-Hsiu Chen

University of Houston

Hitesh Doshi

University of Houston - C.T. Bauer College of Business

Sang Byung Seo

University of Wisconsin - Madison

Date Written: March 30, 2019

Abstract

We synthetically create option contracts on a corporate bond index using CDX swaptions, overcoming the limitations that originate from the lack of traded corporate bond options. Our approach allows us to estimate various risk-neutral quantities concerning the corporate bond market in a model-free manner. By constructing a forward-looking volatility measure and the variance risk premium, we examine the role of volatility risk in the corporate bond market. We highlight that the ex ante conditional second and higher moments we estimate from synthetic corporate bond options carry important implications for credit risk models, providing an extra basis for testing their validity.

JEL Classification: G12, G13

Suggested Citation

Chen, Shu-Hsiu and Doshi, Hitesh and Seo, Sang Byung, Ex Ante Risk in the Corporate Bond Market: Evidence from Synthetic Options (March 30, 2019). Available at SSRN: https://ssrn.com/abstract=3345455 or http://dx.doi.org/10.2139/ssrn.3345455

Shu-Hsiu Chen

University of Houston ( email )

4800 Calhoun Road
Houston, TX 77204
United States

Hitesh Doshi

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Sang Byung Seo (Contact Author)

University of Wisconsin - Madison ( email )

975 University Avenue
Madison, WI 53706-1324

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

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