Pricing the default risk is a hot challenge for every risk manager. The problem is tackled in the framework of the zero-utility principle. According to Pratt (1964), an approximation of the risk premium should be proportional to the Arrow–Pratt absolute risk aversion coefficient and the variance. Is that still true as a default risk is concerned? The answer appears to be negative, because the variance does not look to be an appropriate tool for asymmetrical risk. On the other hand, fear of ruin coefficient and probability of default are proved to be well-tailored tools for a preliminary pricing. Bid and ask price approximations are both elicited and a necessary condition for risk exchange set out.

A shortcut way of pricing default risk through zero-utility principle

TIBILETTI, Luisa
2006

Abstract

Pricing the default risk is a hot challenge for every risk manager. The problem is tackled in the framework of the zero-utility principle. According to Pratt (1964), an approximation of the risk premium should be proportional to the Arrow–Pratt absolute risk aversion coefficient and the variance. Is that still true as a default risk is concerned? The answer appears to be negative, because the variance does not look to be an appropriate tool for asymmetrical risk. On the other hand, fear of ruin coefficient and probability of default are proved to be well-tailored tools for a preliminary pricing. Bid and ask price approximations are both elicited and a necessary condition for risk exchange set out.
73,2
301
306
http://www3.interscience.wiley.com/journal/118601508/abstract?CRETRY=1&SRETRY=0
risk aversion; default risk; fear of ruin
L. TIBILETTI
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Utilizza questo identificativo per citare o creare un link a questo documento: http://hdl.handle.net/2318/9914
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