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Default risk and option returns

Aurelio, V. & Xiao, X. ORCID: 0000-0002-0564-9795 (2023). Default risk and option returns. Management Science, 70(4), pp. 2144-2167. doi: 10.1287/mnsc.2023.4796


This paper studies the effects of default risk on expected equity option returns. We show that there is a cross-sectional and a time-series relation between default risk and expected option returns. In the cross-section, expected delta-hedged equity option returns have a negative relation with default risk measured by credit ratings or default probability. In the time-series, credit rating downgrades (upgrades) lead to a decrease (increase) in the firm’s delta-hedged option return. Our results are consistent with a stylized capital structure model where the negative relation between option returns and default risk is driven by firm leverage and asset volatility.

Publication Type: Article
Publisher Keywords: Delta-Hedged Option Returns, Default Risk, Variance Risk Premium, Volatility, Capital Structure Model
Subjects: H Social Sciences > HG Finance
Departments: Bayes Business School > Finance
SWORD Depositor:
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