Title :
A tree model for pricing credit spread options subject to equity, and market risk
Author :
Xu, Ruxing ; Li, Shenghong
Author_Institution :
Dept. of Math., Zhejiang Univ., Hangzhou, China
Abstract :
This article presents a trinomial tree model for pricing American credit spread options (CSOs) on a defaultable zero-coupon bond with equity and market risk. Interest rates are assumed to follow a mean-reverting square root process. The reduced-form approach is generalized to include a constant elasticity of variance (CEV) process for equity prices prior to default, which is capable of reproducing the volatility smile observed in the empirical data. Based on the empirical results in , the default intensity is specified as a function of the stock price and interest rate. The correlation between interest rates and equity prices is also considered. Illustrative examples show the use of the model and numerical results explain the impact of different parameters on the prices of CSOs.
Keywords :
pricing; risk management; share prices; statistical analysis; stock markets; trees (mathematics); CEV process; CSO; constant elasticity-of-variance; defaultable zero-coupon bond; equity price; mean-reverting square root process; pricing American credit spread option; reduced-form approach; statistical analysis; stock market risk; trinomial tree model; Bonding; Communication system control; Cost accounting; Economic indicators; Mathematical model; Mathematics; Pricing; Risk management; Stochastic processes; Transforms; American credit spread options; CEV process; credit risk; default intensity; tree model;
Conference_Titel :
Computing, Communication, Control, and Management, 2009. CCCM 2009. ISECS International Colloquium on
Conference_Location :
Sanya
Print_ISBN :
978-1-4244-4247-8
DOI :
10.1109/CCCM.2009.5267993
