We propose a novel method of estimating default probabilities using equity option data. The resulting default probabilities are highly correlated with estimates of default probabilities extracted from CDS spreads, which assume constant recovery rates. Additionally, the option implied default probabilities are higher in bad economic times and for ﬁrms with poorer credit ratings and ﬁnancial positions. An inferred recovery rate, after controlling for liquidity eﬀects, is also related to underlying business and ﬁrm conditions, varies across sectors and predicts subsequent equity returns.
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