Pricing Options on Defaultable Stocks

Bayraktar, Erhan

Pricing Options on Defaultable Stocks

Applied Mathematical Finance, 2008, vol. 15, issue 3, 277-304

Abstract: † Stock option price approximations are developed for a model which takes both the risk of default and the stochastic volatility into account. The intensity of defaults is assumed to be influenced by the volatility. It is shown that it might be possible to infer the risk neutral default intensity from the stock option prices. The proposed option price approximation has a rich implied volatility surface structure and fits the data implied volatility well. A calibration exercise shows that an effective hazard rate from bonds issued by a company can be used to explain the impliedvolatility skew of the option prices issued by the same company. It is also observed that the implied yield spread obtained from calibrating all the model parameters to the option prices matches the observed yield spread.

Keywords: Option pricing; multiscale perturbation methods; defaultable stocks; stochastic intensity of default; implied volatility skew (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (4)

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DOI: 10.1080/13504860701798283

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