Differences in the Prices of Vulnerable Options with Different Counterparties

Abstract

In this paper, a new pricing model is proposed to investigate the differences in the prices of vulnerable options with different counterparties. I start by specifying the dynamics of the market portfolio, and then break down the risk of the underlying asset and the assets of the counterparties into systematic and idiosyncratic risk, which allows me to distinguish the counterparties from these two kinds of risk. Finally, the derived pricing formulae are used to illustrate the differences between vulnerable option prices. © 2016 Wiley Periodicals, Inc. Jrl Fut Mark 37:148–163, 2017

Analytical valuation of Asian options with counterparty risk under stochastic volatility models

“…Wang's (2017a) model and a special case of the proposed model, where idiosyncratic volatilities of the underlying asset and the asset of the issuer are constants, that is, To this end, we contrast the numerical results implied by the proposed model with those implied by X.…”

“…Wang's (2017a) model and the special case of the proposed model mentioned above shows the effect of stochastic volatility of the market index. Hence, the difference between option prices from X.…”

“…For instance, Tsao and Liu (2012) obtain approximation formulae for arithmetic Asian options subject to credit risk and show how the issuers' characteristics affect the credit discount of Asian options. Wang (2017a), and the differences in option prices implied by the proposed model and X. However, different from these studies, we work under a general framework, which captures leverage effects as well as stochastic correlation between assets.…”

“…Jeon, Yoon, and Kang (2016) derive the closed-form pricing formula of vulnerable geometric Asian options for fixed and floating strike options with two assets captured by two correlated geometric Brownian motions. Wang's (2017a) model show the effects of stochastic volatilities of the market index, the underlying asset, and the issuer's assets. The proposed framework essentially generalizes the model in X.…”

“…However, different from these studies, we work under a general framework, which captures leverage effects as well as stochastic correlation between assets. Wang (2017a). Wang (2017a), and the differences in option prices implied by the proposed model and X.…”