A Shortcut Way of Pricing Default Risk Through Zero-Utility Principle

6 Pages Posted: 30 May 2006

See all articles by Luisa Tibiletti

Luisa Tibiletti

University of Turin - Department of Management

Abstract

Pricing the default risk is a hot challenge for every risk manager. The problem is tackled in the framework of the zero-utility principle. According to Pratt (1964), an approximation of the risk premium should be proportional to the Arrow-Pratt absolute risk aversion coefficient and the variance. Is that still true as a default risk is concerned? The answer appears to be negative, because the variance does not look to be an appropriate tool for asymmetrical risk. On the other hand, fear of ruin coefficient and probability of default are proved to be well-tailored tools for a preliminary pricing. Bid and ask price approximations are both elicited and a necessary condition for risk exchange set out.

Suggested Citation

Tibiletti, Luisa, A Shortcut Way of Pricing Default Risk Through Zero-Utility Principle. Journal of Risk & Insurance, Vol. 73, No. 2, pp. 303-308, June 2006. Available at SSRN: https://ssrn.com/abstract=904903 or http://dx.doi.org/10.1111/j.1539-6975.2006.00176.x

Luisa Tibiletti (Contact Author)

University of Turin - Department of Management ( email )

C.so Unione Sovietica, 218 bis
Turin, Turin 10100
Italy
39-11-670-6229 (Phone)
39-11-670-6238 (Fax)

HOME PAGE: http://www.management.unito.it/tibiletti

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