Lehman and Jp Morgan, We Consider a Research Proposal

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Lehman and JP Morgan, we consider a period of four months as our observation window, for the years starting in 2006 to 2009. We use the KMV definition of debt as short-term liabilities plus half long-term liabilities. The interest rate is given by the 4-mos. LIBOR or swap rates. For illustration purposes, we use 5%. The benchmark index is given by the S&P500 index. The initial asset values are given by the sum of equity market cap plus liabilities and consequently derived via the Merton call option pricing framework described previously.

The table below depicts the range of minimum and maximum values for the component variables, whereby the EW Index score is given by the weighted average of the following indicators: idiosyncratic-specific volatility, default probability (given historical equity stock prices), default probability (given option prices), default probability (given CDS prices), market deviation (stock return vs. benchmark index return), country-specific risk, and rating grade.

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The table below depicts the range of values for the main indicators and their underlying component variables.

Asset

Asset Vol

Specific Vol

Yearly

Return

DD

PD

Equity

Dev

Asset

Asset

Vol

DD

PD

Options

PD

CDS

EW Index

LEH

min

0,014

0,191

-0,965

-4,7

0

0

0,211

-3,6

0

0,010

0,08

5231589

7,953

1

0,024

10,9

1

1

4976442

4,575

11,2

1

1

0,96

JPM

min

7894566

0,134

0,102

-0,095

0,42

0

0

7555353

0,134

0,7

0

0,006

0,05

22492851

1,428

1

0,058

20,5

1

1

21401119

1,156

20,7

0,94

0,171

0,66

As illustrated in the table above, idiosyncratic risk and default probability rise in tandem during times of distress and point to a higher EW.....

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