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Activity Number: 65 - Building a New and Essential Statistics Toolbox for Challenges in Finance and Business Analytics
Type: Topic Contributed
Date/Time: Sunday, July 30, 2017 : 4:00 PM to 5:50 PM
Sponsor: Business and Economic Statistics Section
Abstract #324195 View Presentation
Title: Firm-Speci c Risk-Neutral Distributions: The Role of CDS Spreads
Author(s): Mohammad Jahan-Parvar* and Sirio Aramonte and Samuel Rosen and John Schindler
Companies: Federal Reserve Board of Governors and Federal Reserve Board and University of North Carolina, Kenan-Flagler Business School and Federal Reserve Board
Keywords: risk-neutral distributions ; CDS spreads ; cross-section of stock returns

We propose a methodology to extract the risk-neutral distribution of a fi rm's expected stock returns by blending option prices and CDS spreads, with the former providing information about the central part of the distribution, and the latter determining the left tail. We apply the methodology to a sample of risky U.S. fi rms. We assess the economic value of estimating risk-neutral distributions with both options and CDS with a series of asset pricing tests. We find that a factor that buys (sells) stocks for which the option/CDS distributions imply a larger (smaller) probability of poor returns than the option-only distributions earns an economically and statistically signifi cant risk premium. These results con rm that blending options and CDS data adds meaningful economic information.

Authors who are presenting talks have a * after their name.

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