Power Exchange Option with a Hybrid Credit Risk under Jump-Diffusion Model

Junkee Jeon and Geonwoo Kim
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Junkee Jeon: Department of Applied Mathematics & Institute of Natural Science, Kyung Hee University, Seoul 17104, Korea
Geonwoo Kim: School of Liberal Arts, Seoul National University of Science and Technology, Seoul 01811, Korea

Mathematics, 2021, vol. 10, issue 1, 1-12

Abstract: In this paper, we study the valuation of power exchange options with a correlated hybrid credit risk when the underlying assets follow the jump-diffusion processes. The hybrid credit risk model is constructed using two credit risk models (the reduced-form model and the structural model), and the jump-diffusion processes are proposed based on the assumptions of Merton. We assume that the dynamics of underlying assets have correlated continuous terms as well as idiosyncratic and common jump terms. Under the proposed model, we derive the explicit pricing formula of the power exchange option using the measure change technique with multidimensional Girsanov’s theorem. Finally, the formula is presented as the normal cumulative functions and the infinite sums.

Keywords: power exchange option; jump-diffusion model; credit risk; option valuation (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2021
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