Pricing vulnerable options in a hybrid credit risk model driven by Heston–Nandi GARCH processes

Gechun Liang and Xingchun Wang ()
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Gechun Liang: University of Warwick

Review of Derivatives Research, 2021, vol. 24, issue 1, No 1, 30 pages

Abstract: Abstract This paper proposes a hybrid credit risk model, in closed form, to price vulnerable options with stochastic volatility. The distinctive features of the model are threefold. First, both the underlying and the option issuer’s assets follow the Heston–Nandi GARCH model with their conditional variance being readily estimated and implemented solely on the basis of the observable prices in the market. Second, the model incorporates both idiosyncratic and systematic risks into the asset dynamics of the underlying and the option issuer, as well as the intensity process. Finally, the explicit pricing formula of vulnerable options enables us to undertake the comparative statistics analysis.

Keywords: Vulnerable options; Hybrid credit risk model; Heston–Nandi GARCH model; Closed form formula (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (5)

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Working Paper: Pricing vulnerable options in a hybrid credit risk model driven by Heston-Nandi GARCH processes (2020)
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DOI: 10.1007/s11147-020-09167-z

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