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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. 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

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  1. The Valuation of Options Subject to Default Risk Shen-Yuan Chen Department of Finance Ming Chuan University

  2. Introduction Exchange-listed Options v.s. Unlisted (OTC) Options →Default Risk of the Issuer → Vulnerable option Shen-Yuan Chen

  3. Purpose Extend Klein (1996) vulnerable option pricing model Derive a path-dependent valuation model for vulnerable option Shen-Yuan Chen

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  5. Klein (1996) Model Shen-Yuan Chen

  6. Path-Independent vs Path-Dependent Vulnerable Options Shen-Yuan Chen

  7. Path-Dependent Vulnerable Options Valuation Model Shen-Yuan Chen

  8. 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

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  12. 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

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  19. 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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