The%20Valuation%20of%20Options%20Subject%20to%20Default%20Risk

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• The Valuation of Options Subject to Default Risk
• Shen-Yuan Chen
• Department of Finance
• Ming Chuan University

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Introduction

• Exchange-listed Options
• v.s.
• Unlisted (OTC) Options
• ?Default Risk of the Issuer
• ? Vulnerable option

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Purpose
Extend Klein (1996) vulnerable option pricing
model Derive a path-dependent valuation model
for vulnerable option
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Klein (1996) Model
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Path-Independent vs Path-Dependent Vulnerable
Options
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Path-Dependent Vulnerable Options Valuation Model
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Comparison of Alternative Pricing Models

• Path-Dependent Vulnerable Option
• Klein(1996)
• Black Scholes (1973)
• ?Tables 1 Base Case
• ?Tables 2 V 10
• ?Tables 3 V 8

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Sensitivity Analysis

• ? Figure 1 Counterpartys asset
  value
• ? Figure 2 Volatility of counterpartys
  asset value
• ? Figure 3 Coefficient of correlation
• ? Figures 4 - 7

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Conclusions

• Klein (1996) overestimates vulnerable option
  value
• Counterpartys asset value ?? PDVO ?
• Volatility of counterpartys asset ? ?
  PDVO?
• Correlation between counterpartys asset and
  underlying stock ?? PDVO ?