Price of Risk: Recent Evidence From Large Financials

August 1, 2010

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Format: Chicago

Manmohan Singh, and Karim Youssef. Price of Risk: Recent Evidence From Large Financials, (USA: International Monetary Fund, 2010) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Probability of default (PD) measures have been widely used in estimating potential losses of, and contagion among, large financial institutions. In a period of financial stress however, the existing methods to compute PDs and generate loss estimates that may vary significantly. This paper discusses three issues that should be taken into account in using PD-based methodologies for loss or contagion analyses: (i) the use of - risk-neutral probabilities - vs. -real-world probabilities; - (ii) the divergence between movements in credit and equity markets during periods of financial stress; and (iii) the assumption of stochastic vs. fixed recovery for financial institutions’ assets. All three elements have nontrivial implications for providing an accurate estimate of default probabilities and associated losses as inputs for setting policies related to large banks in distress.

Subject: Banking, Credit, Credit default swap, Financial crises, Financial markets, Money, Securities markets, Stock markets

Keywords: CDS spread, CDS SpreadEDF, CDS SpreadEquity market signal, Cheapest-to-deliver bonds, Credit, Credit default swap, Distance-to-distress, Equity market volatility, Global, JPoD, LCFIs, Price of risk, Real-world probabilities, Risk neutrality assumption, Risk-neutral probabilities, Sc, Securities markets, Stock markets, WP

Publication Details

Pages:

12
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2010/190
Stock No:

WPIEA2010190
ISBN:

9781455202249
ISSN:

1018-5941

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