Updating the Option Implied Probability of Default Methodology

Abstract

In this paper we ‘update’ the option implied probability of default (option iPoD) approach
recently suggested in the literature. First, a numerically more stable objective function for
the estimation of the risk neutral density is derived whose integrals can be solved analytically.
Second, it is reasoned that the originally proposed approach for the estimation of the PoD
has some serious drawbacks and hence an alternative procedure is suggested that is based
on the Lagrange multipliers. Carrying out numerical evaluations and a practical application
we find that the framework provides very promising results.