communication: RISK I: The Relationship between Risk-Neutral and Actual Default Probabilities: the Credit Risk Premium
speaker: Jessica Caribonispeaker: Wouter Heynderickx
speaker: Bert Smits
abstract: The relationship between the riskneutral measure Q and the actual or realworld measure P, and the corresponding credit risk premium, are investigated in this paper. Quantifying and understanding the longterm average risk premium is important for a variety of financial applications and investment decisionmaking. This study develops an empirical analysis of this relationship, using CDS spreads of European corporates for estimating riskneutral probabilities, and Moody's historical transition matrices to derive the corresponding actual values. Special attention is given to the recent financial crises and our study allows us to quantify its impact on risk premia. In line with some research based on precrisis data, we find that the ratio between the riskneutral and actual default intensities, which we call the coverage ratio, is a convex and decreasing function of the actual default intensities. We are able to further differentiate between different timehorizons and conclude that current risk premia levels are still above their initial levels and this could indicate a permanent upward shift in risk premia. Finally, we link our results with the concept of Real Economic Value and its role in the bailout of several European financial institutions.
timetable:
Thu 28 Jan, 9:00 - 10:30, Sala Azzurra
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