The Credit Risk and Pricing of OTC Options

TY - JOUR

T1 - The Credit Risk and Pricing of OTC Options

AU - Liang, Gechun

AU - Ren , Xuemin

PY - 2007/3

Y1 - 2007/3

N2 - In the over-the-counter (OTC) markets, the options traded are always subject to credit risk. Therefore the counterparty’s credit risk is a striking factor when pricing options,whereas it is not considered in the classic Black-Scholes models. Based on the first passage timemodels, this paper develops the credit risk and valuation model for the European options in the OTC markets, incorporating a practical default trigger mechanism. The default probability and the pricing formulae of the OTC options are obtained by using partial differential equation (PDE) techniques, especially Green’s function.

AB - In the over-the-counter (OTC) markets, the options traded are always subject to credit risk. Therefore the counterparty’s credit risk is a striking factor when pricing options,whereas it is not considered in the classic Black-Scholes models. Based on the first passage timemodels, this paper develops the credit risk and valuation model for the European options in the OTC markets, incorporating a practical default trigger mechanism. The default probability and the pricing formulae of the OTC options are obtained by using partial differential equation (PDE) techniques, especially Green’s function.

KW - Credit risk

KW - OTC options

KW - Default probability

KW - Valuation

KW - Green’s function

U2 - 10.1007/s10690-007-9053-x

DO - 10.1007/s10690-007-9053-x

M3 - Article

SN - 1387-2834

VL - 14

SP - 45

EP - 68

JO - Asia-Pacific Financial Markets

JF - Asia-Pacific Financial Markets

IS - 1-2

ER -