ANALYTICAL VALUATION OF VULNERABLE OPTIONS IN A DISCRETE-TIME FRAMEWORK. Issue 1 (13th September 2016)

• Record Type: Journal Article
• Authors: Wang, Xingchun
• Is Part Of: Probability in the engineering and informational sciences. Volume 31:Issue 1(2017)
• Page Start: 100
• Page End: 120
• Publication Date: 2016-09-13
• Subjects: mathematical finance; Probabilities -- Periodicals; Engineering -- Statistical methods -- Periodicals; Information science -- Statistical methods -- Periodicals; 519.202462
• DOI: 10.1017/S0269964816000292
• Languages: English
• ISSNs: 0269-9648

Abstract

Abstract : In this paper, we present a pricing model for vulnerable options in discrete time. A Generalized Autoregressive Conditional Heteroscedasticity process is used to describe the variance of the underlying asset, which is correlated with the returns of the asset. As for counterparty default risk, we study it in a reduced form model and the proposed model allows for the correlation between the intensity of default and the variance of the underlying asset. In this framework, we derive a closed-form solution for vulnerable options and investigate quantitative impacts of counterparty default risk on option prices.