Contingent Claims and Hedging of Credit Risk with Equity Options

Avino, Davide and Salvador, E (2018) Contingent Claims and Hedging of Credit Risk with Equity Options. The Review of Asset Pricing Studies. raae005-.

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Official URL: https://doi.org/10.1093/rapstu/raae005

Abstract

Using contingent-claims valuation, we introduce novel hedge ratios for credit exposures using put options. Option hedge ratios are generally in line with the empirical sensitivities of credit spread changes to put option returns and, relative to stock hedge ratios, produce further reductions in volatility for a portfolio of North American firms. We show that option hedge ratios capture option-specific credit exposure related to the VIX index and the default spread, which is unaccounted for by Merton’s (1974) equity hedge ratios alone. Combining stocks and put options for credit risk hedging can be done effectively using the volatility smirk. (JEL E43, E44, G10)

Item Type:	Article
Uncontrolled Keywords:	Credit Risk, Contingent Claims, Hedging, CDS, Options
Divisions:	Faculty of Humanities and Social Sciences > School of Management
Depositing User:	Symplectic Admin
Date Deposited:	02 Apr 2024 16:54
Last Modified:	04 Apr 2024 08:38
DOI:	10.1093/rapstu/raae005
Open Access URL:	https://doi.org/10.1093/rapstu/raae005
Related URLs:	Publisher
URI:	https://livrepository.liverpool.ac.uk/id/eprint/3180029