Pricing vulnerable options with stochastic liquidity risk

Xingchun Wang ()

The North American Journal of Economics and Finance, 2022, vol. 60, issue C

Abstract: In this paper, we consider vulnerable options with stochastic liquidity risk. We employ liquidity-adjusted pricing models to describe the underlying stock price and option issuer’s assets. In addition, the correlation between these assets is stochastic, depending on the market liquidity measures. In the proposed framework, we derive closed forms of vulnerable European options with stochastic liquidity risk and then use them to illustrate the effects of stochastic liquidity risk on vulnerable option prices. Numerical results show that the effects of liquidity risk on the prices of out-of-the-money options or the options with a short maturity are not negligible.

Keywords: Vulnerable options; Stochastic liquidity risk; Counterparty default risk; OTC markets (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:60:y:2022:i:c:s1062940821002278

DOI: 10.1016/j.najef.2021.101637

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