Valuation of American options in the presence of event risk

Alex Szimayer ()

Finance and Stochastics, 2005, vol. 9, issue 1, 89-107

Abstract: This paper studies the valuation of American options in the presence of external/non-hedgeable event risk. When the event occurs, the American option is terminated and a rebate is paid instead of the promised pay-off profile. Consequently, the presence of event risk influences the exercise strategy of the option holder. For the financial market in a diffusion setting, the probabilistic structure in terms of equivalent martingale measures is briefly analysed. Then, for a given equivalent martingale measure the optimal stopping problem of the American option is solved. As a main result, no-arbitrage bounds for American option values in the presence of event risk are derived, as well as hedging strategies corresponding to the no-arbitrage bounds. Copyright Springer-Verlag Berlin/Heidelberg 2005

Keywords: American options; Israeli options; event risk (search for similar items in EconPapers)
Date: 2005
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DOI: 10.1007/s00780-004-0141-8

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