Analytical pricing of vulnerable options under a generalized jump–diffusion model

Farzad Alavi Fard

Insurance: Mathematics and Economics, 2015, vol. 60, issue C, 19-28

Abstract: In this paper we propose a model to price European vulnerable options. We formulate their credit risk in a reduced form model and the dynamics of the spot price in a completely random generalized jump–diffusion model, which nests a number of important models in finance. We obtain a closed-form price for the vulnerable option by (1) determining an equivalent martingale measure, using the Esscher transform and (2) manipulating the pay-off structure of the option four further times, by using the Esscher–Girsanov transform.

Keywords: Vulnerable options; Reduced form; Esscher–Girsanov transform; Generalized jump; Credit risk (search for similar items in EconPapers)
JEL-codes: D52 G13 G22 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (26)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:60:y:2015:i:c:p:19-28

DOI: 10.1016/j.insmatheco.2014.10.007

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