The goal of this project is to estimate default probabilities of banks implied by observed market data using the method suggested by Christian Capuano (2008) which was updated by Johannes Vilsmeier (2014).
For a full description of this project and further details, please consult the final report.
Note that the R files must be opened within the corresponding RProject.
This project applies the method of estimating option implied probability of default suggested by Johannes Vilsmeier (2014). Using the principle of minimum cross-entropy and optimisation constraints given by observable market prices, retrieving the probability density function of future asset value is attempted. The obtained probability density function then is integrated up to a threshold chosen to be optimal, resulting in an estimate of the probability of default.
Data since 2021 was obtained for several banks from the polygon.io API. Additionally, data since 2005 was obtained from WRDS for Credit Suisse. All required data is stored in an SQL database. Unfortunately, since the data is not openly accessible, this SQL database cannot be published in this repository.
Although key events are mapped as episodes of increased stress with this indicator, no strong predictive power was found in this specific application.
This project was created as a part of the Seminar "Workshop in Econometrics II" at the University of Bern.