Question

Explain the difference between risk-neutral and real-world default probabilities. Which should be used for valuing CDSs?

   Explain the difference between risk-neutral and real-world default probabilities. Which should be used for valuing CDSs?

Options, Futures, and Other Derivatives

Options, Futures, and Other Derivatives

John C. Hull 10th Edition

Chapter 25, Problem 6

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These probabilities are derived from the prices of credit derivatives, such as credit default swaps (CDSs), and are used in financial models to value these instruments. Risk-neutral default probabilities are typically lower than real-world default probabilities Show more…

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Explain the difference between risk-neutral and real-world default probabilities. Which should be used for valuing CDSs?

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