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Analytical valuation of power exchange options with default risk

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  • Xu, Guangli
  • Shao, Xinjian
  • Wang, Xingchun

Abstract

In this paper, we provide an analytical valuation formula for power exchange options with default risk. The proposed model not only considers the correlations among the two underlying assets and the asset of the counterparty, but also allows for the possible default prior to the maturity of the option. We decompose the risk of all assets into idiosyncratic and systematic parts. By means of the measure-change technique, we obtain a pricing formula for power exchange options with default risk. Finally, numerical results are presented to show the power exchange option values.

Suggested Citation

  • Xu, Guangli & Shao, Xinjian & Wang, Xingchun, 2019. "Analytical valuation of power exchange options with default risk," Finance Research Letters, Elsevier, vol. 28(C), pages 265-274.
    • Handle: RePEc:eee:finlet:v:28:y:2019:i:c:p:265-274
    DOI: 10.1016/j.frl.2018.05.007
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    Cited by:

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    2. Zaevski, Tsvetelin S. & Kounchev, Ognyan & Savov, Mladen, 2019. "Two frameworks for pricing defaultable derivatives," Chaos, Solitons & Fractals, Elsevier, vol. 123(C), pages 309-319.
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    4. Geonwoo Kim, 2020. "Valuation of Exchange Option with Credit Risk in a Hybrid Model," Mathematics, MDPI, vol. 8(11), pages 1-11, November.
    5. Xin‐Jiang He & Sha Lin, 2023. "Analytically pricing exchange options with stochastic liquidity and regime switching," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(5), pages 662-676, May.
    6. Afhami, Bahareh & Rezapour, Mohsen & Madadi, Mohsen & Maroufy, Vahed, 2023. "A comonotonic approximation to optimal terminal wealth under a multivariate Merton model with correlated jump risk," Applied Mathematics and Computation, Elsevier, vol. 444(C).
    7. Wang, Xingchun, 2019. "Valuation of new-designed contracts for catastrophe risk management," The North American Journal of Economics and Finance, Elsevier, vol. 50(C).
    8. Li, Zelei & Wang, Xingchun, 2020. "Valuing spread options with counterparty risk and jump risk," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).

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    More about this item

    Keywords

    Power exchange option; Default risk; Systematic risk; Idiosyncratic risk;
    All these keywords.

    JEL classification:

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

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