Valuing Seller‐Defaultable Options |
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Authors: | Jin‐Ray Lu Yi‐Chun Chen Chih‐Chiang Hwang Yi‐Chun Ting |
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Institution: | 1. Jin‐Ray Lu is an Associate Professor of Finance at the Department of Finance, National Dong Hwa University, Hualien, Taiwan, R.O.C;2. Yi‐Chun Chen is a Lecturer of Finance at the Department of Finance, National Dong Hwa University, Hualien, Taiwan, R.O.C;3. Chih‐Chiang Hwang is a Lecturer of Finance at the Department of Finance, National Dong Hwa University, Hualien, Taiwan, R.O.C;4. Yi‐Chun Ting is a Revenue Officer at the Taipei Revenue Service, Taipei, Taiwan, R.O.C |
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Abstract: | This study analyzes seller‐defaultable options that allow option writers to have a free‐will right to default, along with some prespecified default mechanisms. We analytically and numerically examine the pricing, hedging, defaulting, and profitability of the seller‐defaultable options, considering three possible scenarios for seller default. Analyzing the essential implications of seller‐defaultable options, we show that the option price is positively correlated with the default fine, underlying asset price, and volatility. The seller‐defaultable option's Greeks appear more complicated than those of the plain vanilla options. The likelihood of sellers defaulting increases with the underlying asset price, interest rate, volatility, and maturity time. Subject to the default mechanism, the buyers’ trading involves a trade‐off between profits and costs. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:129–157, 2013 |
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