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A CERTAINTY EQUIVALENT APPROACH TO MUNICIPAL BOND DEFAULT RISK ESTIMATION
Author(s) -
Wu Chunchi
Publication year - 1991
Publication title -
journal of financial research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.319
H-Index - 49
eISSN - 1475-6803
pISSN - 0270-2592
DOI - 10.1111/j.1475-6803.1991.tb00661.x
Subject(s) - econometrics , default risk , economics , risk aversion (psychology) , estimation , bond , actuarial science , neutrality , probability of default , credit risk , financial economics , expected utility hypothesis , finance , philosophy , management , epistemology
This paper extends the risk‐neutrality default model of municipal bonds to consider the effect of risk aversion on the estimation of default probability. A model is proposed to separate the default risk assessment from the investor's risk aversion. Empirical results show that the risk‐neutrality model consistently overestimates the default probability but that the magnitude of this overestimate is generally small and statistically insignificant.