Pricing vulnerable European options with dynamic correlation between market risk and credit risk
In this paper, we study the valuation of vulnerable European options incorporating the reduced-form approach, which models the credit default of the counterparty. We provide an analytical pricing model in which the components of the state processes, including the dynamics of the underlying asset val...
| Main Authors: | , , |
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| Format: | Article |
| Language: | English |
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KeAi Communications Co., Ltd.
2020-06-01
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| Series: | Journal of Management Science and Engineering |
| Subjects: | |
| Online Access: | http://www.sciencedirect.com/science/article/pii/S2096232020300160 |
| _version_ | 1818291405561266176 |
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| author | Huawei Niu Yu Xing Yonggan Zhao |
| author_facet | Huawei Niu Yu Xing Yonggan Zhao |
| author_sort | Huawei Niu |
| collection | DOAJ |
| description | In this paper, we study the valuation of vulnerable European options incorporating the reduced-form approach, which models the credit default of the counterparty. We provide an analytical pricing model in which the components of the state processes, including the dynamics of the underlying asset value and the intensity process corresponding to the default event, are cross-exciting and they could facilitate the description of complex structure of events dependence. To illustrate how our model works, we present an application when the state variables follow specific affine jump-diffusion processes. Semi-analytical pricing formulae are obtained through a system of matrix Riccati equations. The derived formula can be implemented numerically, and we give numerical analysis to investigate the impact of the dynamic correlation between jump risk of the underlying asset value and default risk of the counterparty. |
| first_indexed | 2024-12-13T02:43:33Z |
| format | Article |
| id | doaj.art-d7786954207543c9aa0005215b427db3 |
| institution | Directory Open Access Journal |
| issn | 2096-2320 |
| language | English |
| last_indexed | 2024-12-13T02:43:33Z |
| publishDate | 2020-06-01 |
| publisher | KeAi Communications Co., Ltd. |
| record_format | Article |
| series | Journal of Management Science and Engineering |
| spelling | doaj.art-d7786954207543c9aa0005215b427db32022-12-22T00:02:14ZengKeAi Communications Co., Ltd.Journal of Management Science and Engineering2096-23202020-06-0152125145Pricing vulnerable European options with dynamic correlation between market risk and credit riskHuawei Niu0Yu Xing1Yonggan Zhao2School of Economics and Management, China University of Mining and Technology, Xuzhou, 221116, China; School of Finance, Nanjing Audit University, Nanjing, 211815, China; Corresponding author. School of Economics and Management, China University of Mining and Technology, Xuzhou, 221116, China.School of Finance, Nanjing Audit University, Nanjing, 211815, ChinaRowe School of Business, Dalhousie University, Halifax, B3H 4R2, CanadaIn this paper, we study the valuation of vulnerable European options incorporating the reduced-form approach, which models the credit default of the counterparty. We provide an analytical pricing model in which the components of the state processes, including the dynamics of the underlying asset value and the intensity process corresponding to the default event, are cross-exciting and they could facilitate the description of complex structure of events dependence. To illustrate how our model works, we present an application when the state variables follow specific affine jump-diffusion processes. Semi-analytical pricing formulae are obtained through a system of matrix Riccati equations. The derived formula can be implemented numerically, and we give numerical analysis to investigate the impact of the dynamic correlation between jump risk of the underlying asset value and default risk of the counterparty.http://www.sciencedirect.com/science/article/pii/S2096232020300160Vulnerable optionsReduced-form modelCredit riskFourier transformAffine jump-diffusion |
| spellingShingle | Huawei Niu Yu Xing Yonggan Zhao Pricing vulnerable European options with dynamic correlation between market risk and credit risk Journal of Management Science and Engineering Vulnerable options Reduced-form model Credit risk Fourier transform Affine jump-diffusion |
| title | Pricing vulnerable European options with dynamic correlation between market risk and credit risk |
| title_full | Pricing vulnerable European options with dynamic correlation between market risk and credit risk |
| title_fullStr | Pricing vulnerable European options with dynamic correlation between market risk and credit risk |
| title_full_unstemmed | Pricing vulnerable European options with dynamic correlation between market risk and credit risk |
| title_short | Pricing vulnerable European options with dynamic correlation between market risk and credit risk |
| title_sort | pricing vulnerable european options with dynamic correlation between market risk and credit risk |
| topic | Vulnerable options Reduced-form model Credit risk Fourier transform Affine jump-diffusion |
| url | http://www.sciencedirect.com/science/article/pii/S2096232020300160 |
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