The Valuation of Options Subject to Default Risk
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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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The valuation of options subject to default risk shen yuan chen department of finance

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


The valuation of options subject to default risk shen yuan chen department of finance

Purpose

Extend Klein (1996) vulnerable option pricing model

Derive a path-dependent valuation model for vulnerable option

Shen-Yuan Chen



The valuation of options subject to default risk shen yuan chen department of finance

Klein (1996) Model

Shen-Yuan Chen


The valuation of options subject to default risk shen yuan chen department of finance

Path-Independent vs Path-Dependent Vulnerable Options

Shen-Yuan Chen


Path dependent vulnerable options valuation model
Path-Dependent Vulnerable Options Valuation 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