The Default Probability of Firms Implied by Their Equity Options Volatility Surfaces
<-- Return to the list
Date: 09-22-2003
Start Time:
5:30pm
End Time: 7:00pm
Speaker: Joe Zou, Goldman, Sachs & Co.
Location: Interschool Lab, Schapiro CEPSR
ABSTRACT
We examine the relationship between leveraged firms' default probabilities and
their equity options' implied volatility surfaces. We extract asset value
distributions consistent with the equity options volatility skew and term
structure. The model inputs include only observable equity options market data
plus the expected recovery rate in a default event. The equity option implied
asset value distributions do not rely on assumptions about the stochastic
process followed by the assets. Numerical implementation of the model is
straightforward and robust. Application of the model to current credit default
swap market yields promissing results.
Outline of the
presentation:
. A brief review of structural models for risky debt
valuation
. Extraction of the default probability based on the information
embedded in the equity options volatility surface
. Term structure of default
probabilities and credit default swap valuation
. Numerical
Implementations
. Empirical tests and results
. Greeks of Credit Default
Swaps
. Concluding remarks
BIO
Dr. Zou is a Vice President with the GSPS volatility trading group at Goldman, Sachs & Co. Since joining Goldman Sachs in 1994, he has played a wide range of roles in developing equity derivatives pricing and risk management models, equity volatility trading strategies, and proprietary trading. He holds a Ph.D. in theoretical physics from Princeton University. Prior to joining Goldman Sachs, he was a Research Associate at Stanford University and a long-term Research Fellow at the Institute for Advanced Study in Princeton. Dr. Zou is based in New York.