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Valuation of vulnerable options using a bivariate Gram–Charlier approximation

Author

Listed:
  • Dingding Dong

    (Jilin University)

  • Xinyue Ou

    (University of International Business and Economics)

  • Xingchun Wang

    (University of International Business and Economics)

Abstract

In this paper, we focus on vulnerable options using the bivariate Gram–Charlier approximation, rather than any specific stochastic processes as in previous studies on vulnerable options. After deriving a closed-form pricing formula of vulnerable options, we perform numerical examples to illustrate the effects of the (co)skewness and excess (co)kurtosis parameters. Numerical results show that the skewness (excess kurtosis) parameters of the underlying asset and the issuer’s assets have opposite effects on vulnerable option prices. Specially, all the counterintuitive observations are explained by emphasizing the role of the risk compensation item.

Suggested Citation

  • Dingding Dong & Xinyue Ou & Xingchun Wang, 2025. "Valuation of vulnerable options using a bivariate Gram–Charlier approximation," Review of Derivatives Research, Springer, vol. 28(1), pages 1-30, April.
    • Handle: RePEc:kap:revdev:v:28:y:2025:i:1:d:10.1007_s11147-024-09207-y
    DOI: 10.1007/s11147-024-09207-y
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    References listed on IDEAS

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    9. 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.
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    More about this item

    Keywords

    Vulnerable options; Gram–Charlier approximation; Skewness; Kurtosis; Default risk;
    All these keywords.

    JEL classification:

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

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