Pricing black-scholes options with correlated interest rate risk and credit risk: An extension

Szu Lang Liao*, Hsing-Hua Huang

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

21 Scopus citations

Abstract

This article provides a closed-form valuation formula for the Black-Scholes options subject to interest rate risk and credit risk. Not only does our model allow for the possible default of the option issuer prior to the option's maturity, but also considers the correlations among the option issuer's total assets, the underlying stock, and the default-free zero coupon bond. We further tailor-make a specific credit-linked option for hedging the default risk of the option issuer. The numerical results show that the default risk of the option issuer significantly reduces the option values, and the vulnerable option values may be remarkably overestimated in the case where the default can occur only at the maturity of the option.

Original languageEnglish
Pages (from-to)443-447
Number of pages5
JournalQuantitative Finance
Volume5
Issue number5
DOIs
StatePublished - 1 Oct 2005

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