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Valuation of American options in the presence of event risk

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  • Alex Szimayer

Abstract

This paper studies the valuation of American options in the presence of external/non-hedgeable event risk. When the event occurs, the American option is terminated and a rebate is paid instead of the promised pay-off profile. Consequently, the presence of event risk influences the exercise strategy of the option holder. For the financial market in a diffusion setting, the probabilistic structure in terms of equivalent martingale measures is briefly analysed. Then, for a given equivalent martingale measure the optimal stopping problem of the American option is solved. As a main result, no-arbitrage bounds for American option values in the presence of event risk are derived, as well as hedging strategies corresponding to the no-arbitrage bounds. Copyright Springer-Verlag Berlin/Heidelberg 2005

Suggested Citation

  • Alex Szimayer, 2005. "Valuation of American options in the presence of event risk," Finance and Stochastics, Springer, vol. 9(1), pages 89-107, January.
    • Handle: RePEc:spr:finsto:v:9:y:2005:i:1:p:89-107
    DOI: 10.1007/s00780-004-0141-8
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    Cited by:

    1. Gapeev, Pavel V. & Li, Libo, 2022. "Perpetual American standard and lookback options with event risk and asymmetric information," LSE Research Online Documents on Economics 114940, London School of Economics and Political Science, LSE Library.
    2. Libo Li & Ruyi Liu & Marek Rutkowski, 2022. "Vulnerable European and American Options in a Market Model with Optional Hazard Process," Papers 2212.12860, arXiv.org.
    3. Dai, Min & Kwok, Yue Kuen & You, Hong, 2007. "Intensity-based framework and penalty formulation of optimal stopping problems," Journal of Economic Dynamics and Control, Elsevier, vol. 31(12), pages 3860-3880, December.
    4. Zbigniew Palmowski & Paweł Stȩpniak, 2023. "Last-Passage American Cancelable Option in Lévy Models," JRFM, MDPI, vol. 16(2), pages 1-14, January.
    5. Huansang Xu & Ruyi Liu & Marek Rutkowski, 2023. "Equity Protection Swaps: A New Type of Investment Insurance for Holders of Superannuation Accounts," Papers 2305.09472, arXiv.org, revised Apr 2024.

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