Pricing vulnerable spread options with liquidity risk under Lévy processes

Chengyou Cai, Xingchun Wang () and Baimin Yu

The North American Journal of Economics and Finance, 2024, vol. 72, issue C

Abstract: In this paper, we consider vulnerable spread options with stochastic liquidity risk. Lévy processes are introduced to characterize jumps and we allow the liquidity discount factor to be related to a mean-reversion process. Through bivariate Fourier transforms, we successfully get the approximated pricing formula in the proposed model, and numerical experiments show that the approximated prices are very accurate. We finally focus on the impact of asymmetric jump risk and stochastic liquidity risk on vulnerable spread option prices.

Keywords: Stochastic liquidity risk; Mean-reversion processes; Lévy processes; Default risk (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:72:y:2024:i:c:s1062940824000494

DOI: 10.1016/j.najef.2024.102124

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