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Pricing and static hedging of American-style options under the jump to default extended CEV model

João Pedro Ruas, José Carlos Dias and João Pedro Vidal Nunes

Journal of Banking & Finance, 2013, vol. 37, issue 11, 4059-4072

Abstract: This paper prices (and hedges) American-style options through the static hedge approach (SHP) proposed by Chung and Shih (2009) and extends the literature in two directions. First, the SHP approach is generalized to the jump to default extended CEV (JDCEV) model of Carr and Linetsky (2006), and plain-vanilla American-style options on defaultable equity are priced. The robustness and efficiency of the proposed pricing solutions are compared with the optimal stopping approach offered by Nunes (2009), under both the JDCEV framework and the nested constant elasticity of variance (CEV) model of Cox (1975), using different elasticity parameter values. Second, the early exercise boundary near expiration is derived under the JDCEV model.

Keywords: American options; Static hedging; CEV model; JDCEV model; Early exercise boundary (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2013
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Handle: RePEc:eee:jbfina:v:37:y:2013:i:11:p:4059-4072