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ANALYTICAL VALUATION OF VULNERABLE OPTIONS IN A DISCRETE-TIME FRAMEWORK

Published online by Cambridge University Press:  13 September 2016

Xingchun Wang
Xingchun Wang*
Affiliation:
School of International Trade and Economics, University of International Business and Economics, Beijing 100029, People's Republic of China E-mail: xchwangnk@aliyun.com; wangx@uibe.edu.cn
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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.

Keywords

mathematical finance
Type
Research Article
Information
Probability in the Engineering and Informational Sciences , Volume 31 , Issue 1 , January 2017 , pp. 100 - 120
Copyright
Copyright © Cambridge University Press 2016 

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