Valuation of vulnerable American options with correlated credit risk |
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Authors: | Lung-Fu Chang Mao-Wei Hung |
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Institution: | (1) College of Management, National Taiwan University, No. 50, Lane 144, Keelung Rd. Sec. 4, Taipei, 100, Taiwan |
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Abstract: | This article evaluates vulnerable American options based on the two-point Geske and Johnson method. In accordance with the
Martingale approach, we provide analytical pricing formulas for European and multi-exercisable options under risk-neutral
measures. Employing Richardson’s extrapolation gets the values of vulnerable American options. To demonstrate the accuracy
of our proposed method, we use numerical examples to compare the values of vulnerable American options from our proposed method
with the benchmark values from the least-square Monte Carlo simulation method. We also perform sensitivity analyses for vulnerable
American options and show how the prices of vulnerable American options vary with the correlation between the underlying assets
and the option writer’s assets.
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Keywords: | American options Derivatives Default Credit risk Multi-exercisable Martingale |
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