Ex Ante Risk in the Corporate Bond Market: Evidence from Synthetic Options
61 Pages Posted: 25 Mar 2019 Last revised: 17 Aug 2019
Date Written: March 30, 2019
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: Suggested Citation