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The Valuation of Options Subject to Default Risk Shen-Yuan Chen Department of Finance

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The Valuation of Options Subject to Default Risk Shen-Yuan Chen Department of Finance Ming Chuan University. Introduction. Exchange-listed Options v.s. Unlisted (OTC) Options →Default Risk of the Issuer → Vulnerable option. Purpose.

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slide1
The Valuation of Options Subject to Default Risk

Shen-Yuan Chen

Department of Finance

Ming Chuan University

introduction
Introduction

Exchange-listed Options

v.s.

Unlisted (OTC) Options

→Default Risk of the Issuer

→ Vulnerable option

Shen-Yuan Chen

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Purpose

Extend Klein (1996) vulnerable option pricing model

Derive a path-dependent valuation model for vulnerable option

Shen-Yuan Chen

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Klein (1996) Model

Shen-Yuan Chen

comparison of alternative pricing models
Comparison of Alternative Pricing Models
  • Path-Dependent Vulnerable Option
  • Klein(1996)
  • Black & Scholes (1973)

→Tables 1 : Base Case

→Tables 2 : V = 10

→Tables 3 : V = 8

Shen-Yuan Chen

sensitivity analysis
Sensitivity Analysis

→ Figure 1 : Counterparty’s asset value

→ Figure 2 : Volatility of counterparty’s asset value

→ Figure 3 : Coefficient of correlation

→ Figures 4 - 7

Shen-Yuan Chen

conclusions
Conclusions
  • Klein (1996) overestimates vulnerable option value
  • Counterparty’s asset value ↑→ PDVO ↑
  • Volatility of counterparty’s asset ↑ → PDVO↓
  • Correlation between counterparty’s asset and underlying stock ↑→ PDVO ?

Shen-Yuan Chen

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