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Pricing vulnerable options with stochastic default barriers

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  • Wang, Xingchun

Abstract

In this paper, we investigate the pricing issue of vulnerable options by assuming that the dynamics of all assets are governed by jump-diffusion processes with common factors in both continuous process and jump process components. Moreover, assume credit default event occurs when the value of the counterparty’s assets falls below the default barrier, which is stochastically affected by common factors as well. In the proposed framework, we derive a closed-form formula for vulnerable options and illustrate the impacts of stochastic barriers on option prices. Additionally, the U-shape curve appears when we investigate option prices against the volatility of default barriers.

Suggested Citation

  • Wang, Xingchun, 2016. "Pricing vulnerable options with stochastic default barriers," Finance Research Letters, Elsevier, vol. 19(C), pages 305-313.
    • Handle: RePEc:eee:finlet:v:19:y:2016:i:c:p:305-313
    DOI: 10.1016/j.frl.2016.09.005
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    References listed on IDEAS

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    Cited by:

    1. Wang, Guanying & Wang, Xingchun & Shao, Xinjian, 2022. "Exchange options for catastrophe risk management," The North American Journal of Economics and Finance, Elsevier, vol. 59(C).
    2. Xingchun Wang, 2020. "Analytical valuation of Asian options with counterparty risk under stochastic volatility models," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(3), pages 410-429, March.
    3. Gechun Liang & Xingchun Wang, 2021. "Pricing vulnerable options in a hybrid credit risk model driven by Heston–Nandi GARCH processes," Review of Derivatives Research, Springer, vol. 24(1), pages 1-30, April.
    4. Panhong Cheng & Zhihong Xu & Zexing Dai, 2023. "Valuation of vulnerable options with stochastic corporate liabilities in a mixed fractional Brownian motion environment," Mathematics and Financial Economics, Springer, volume 17, number 3, December.
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    6. Xiangdong Liu & Zanbin Zhang, 2023. "Pricing European Vulnerable Options with Jumps and Stochastic Default Obstacles Barrier under Regime Switching," Mathematics, MDPI, vol. 11(19), pages 1-18, October.
    7. Wang, Xingchun, 2020. "Valuation of Asian options with default risk under GARCH models," International Review of Economics & Finance, Elsevier, vol. 70(C), pages 27-40.

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    More about this item

    Keywords

    Vulnerable options; Stochastic default barriers; Common factors; Jump-diffusion processes; Credit risk;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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