Is the following formula correct? RiskNeutralProb= (CreditSpread * Exp(-TreasuryRate * YrsToMaturity))

QuoteOriginally posted by: britanniaIs the following formula correct? RiskNeutralProb= (CreditSpread * Exp(-TreasuryRate * YrsToMaturity))No.

What is the correct formula?

Using the certainty equivalent formula....1/(1+Rf+CS)^T = (PD*RR +1-PD)/(1+Rf)^T where PD: Risk-Neutral Probability of Default, RR: recovery rate, CS: credit spread, Rf: Riskfree ratePD = (1 - ((1+Rf)/(1+Rf+CS))^T)/(1-RR)

QuoteOriginally posted by: weareUsing the certainty equivalent formula....1/(1+Rf+CS)^T = (PD*RR +1-PD)/(1+Rf)^T where PD: Risk-Neutral Probability of Default, RR: recovery rate, CS: credit spread, Rf: Riskfree ratePD = (1 - ((1+Rf)/(1+Rf+CS))^T)/(1-RR)Yes, Weare is correct in the case that we assume that at the default time, the value of a corporate zero coupon bond is recovery times the value of the corresponding risk free zero coupon bond. This is what many people use. If you make different assumptions about what and when you recover, you get different expressions for default probabilities. When spreads are small these different expressions yield very similar def probs. The above could be thought of as recovery of face value on zero coupon bonds BUT paid at maturity.See also....http://www.stanford.edu/~duffie/jstorlinks/ds2.pdf