The Valuation of Options on Bonds with Default Risk

Riadh Belhaj
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Riadh Belhaj: Conservatoire National des Arts et Metiers, France

Multinational Finance Journal, 2006, vol. 10, issue 3-4, 277-306

Abstract: In this paper we present a model for valuing European and American options, which incorporates both default and interest rate risks. We develop a framework that permits evaluation of three kinds of options: (i) options issued by default-free counterparties on risky bonds, (ii) options issued by risky counterparties on default-free bonds and (iii) options issued by risky counterparties on risky bonds — a case where default risk enters at both levels. We show that the price of a put option on a risky discount bond is hump shaped for a European put and monotone increasing for an American put. We also find that the price impact of default risk is less for an American put option than for a European one.

Keywords: option pricing; default risk; defaultable bonds; vulnerable options (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:mfj:journl:v:10:y:2006:i:3-4:p:277-306

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