Debt rollover-induced local volatility model

Oleg Sokolinskiy ()
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Oleg Sokolinskiy: Rutgers Business School - Newark and New Brunswick

Review of Quantitative Finance and Accounting, 2019, vol. 52, issue 4, No 6, 1065-1084

Abstract: Abstract This paper introduces a structural scenario-based model with debt rollover risk and a higher-fidelity treatment of the bankruptcy procedure. The emerging stock price process is a generalized Brownian motion with state-dependent local volatility, and the resultant implied volatility smile is due exclusively to structural features (debt rollover and credit risks). Therefore, the model reinforces structural foundations of local volatility option pricing models. The paper advocates a joint modeling and calibration framework for multiple classes of derivatives on the firm’s asset value. In particular, an empirical application to Solar City equity and stock option valuation demonstrates the versatility and efficiency gains of the suggested model.

Keywords: Option pricing; Rollover risk; Credit risk; Local volatility; Volatility smile; Reorganization (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:kap:rqfnac:v:52:y:2019:i:4:d:10.1007_s11156-018-0736-3

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DOI: 10.1007/s11156-018-0736-3

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