The implied volatility of options on equities can be useful in predicting credit spreads and default recoveries. John Hull, Maple Financial Group professor of derivatives and risk management in the Joseph L. Rotman School of Management at the University of Toronto, said credit spreads and at-the-money option volatility have a positive convex relationship. Incorporating option implied volatilities into Merton's model is more useful in predicting credit spreads and defaults than the traditional implementation of the model, he said.
Option Vol Can Help Pick Potential Credit Defaults
