M. Cremers, J. Driessen, and P. Maenhout: Explaining the Level of Credit Spreads: Option-Implied Jump Risk Premia in a Firm Value Model

October 19, 2006

Prices of equity index put options contain information on the price of systematic downward jump risk. We use a structural jump-diffusion firm value model to assess the level of credit spreads that is generated by option-implied jump risk premia. In our compound option pricing model, an equity index option is an option on a portfolio of call options on the underlying firm values. We calibrate the model parameters to historical information on default risk, the equity premium and equity return distribution, and S&P 500 index option prices.