Pricing of vulnerable exchange options with early counterparty credit risk

Donghyun Kim, Geonwoo Kim and Ji-Hun Yoon

The North American Journal of Economics and Finance, 2022, vol. 59, issue C

Abstract: The exchange option is one of the most popular options in the over-the-counter (OTC) market, which enables the holder of two underlying assets to exchange one with another. In OTC markets, with the increasing apprehension of credit default risk in the case of option pricing since the global financial crisis, it has become necessary to consider the counterparty credit risk while evaluating the option price. In this study, we combine the vulnerable exchange option and early counterparty default risk to obtain the closed-form formula for the vulnerable exchange option with early counterparty credit risk by using the method of dimension reduction, Mellin transform, and the method of images. Moreover, we examine the pricing accuracy of the option value by comparing our closed-form solution with the formula derived by the Monte-Carlo simulation.

Keywords: Early counterparty default risk; Vulnerable exchange option; Method of images; Double Mellin transform; Monte Carlo method (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:59:y:2022:i:c:s1062940821002187

DOI: 10.1016/j.najef.2021.101624

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