Credit risk in derivative securities: A simplified approach

Rainer Baule

Journal of Futures Markets, 2021, vol. 41, issue 5, 641-657

Abstract: The pricing of options and other derivatives which are subject to the default risk of the writer usually requires the calibration of a sophisticated model and substantial effort in determining the input parameters. We propose a very simple method to incorporate correlated credit risk into the pricing of vulnerable derivatives. The approach is based upon some approximations of more complex models and requires a minimum of input parameters. It is therefore easily applicable and maintains the accuracy of sophisticated models to a large extent, as shown in numerical studies for call options, put options, and discount certificates.

Date: 2021
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