### Abstract

In order to handle option writer’s credit risk, a different underlying price model is required beyond the well-known Black-Scholes model. This paper adopts a recently developed model, which characterizes the 2007-2009 global financial crisis in a unique way, to determine the no-arbitrage price of European options vulnerable to writer’s default possibility. The underlying model is based on the randomization of the elasticity of variance parameter capturing the leverage or inverse leverage effect. We obtain an analytic formula explicitly for the stochastic elasticity of variance correction to the Black-Scholes price of vulnerable options and show how the correction effect is compared with the one given by the constant elasticity of variance model. The result can help to design a dynamic investment strategy reducing option writer’s credit risk more effectively.

Original language | English |
---|---|

Pages (from-to) | 233-247 |

Number of pages | 15 |

Journal | Economic Computation and Economic Cybernetics Studies and Research |

Volume | 51 |

Issue number | 1 |

Publication status | Published - 2017 Jan 1 |

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### All Science Journal Classification (ASJC) codes

- Economics and Econometrics
- Computer Science Applications
- Applied Mathematics

### Cite this

*Economic Computation and Economic Cybernetics Studies and Research*,

*51*(1), 233-247.

}

*Economic Computation and Economic Cybernetics Studies and Research*, vol. 51, no. 1, pp. 233-247.

**Pricing vulnerable options with constant elasticity of variance versus stochastic elasticity of variance.** / Lee, Min Ku; Yang, Sung Jin; Kim, Jeong Hoon.

Research output: Contribution to journal › Article

TY - JOUR

T1 - Pricing vulnerable options with constant elasticity of variance versus stochastic elasticity of variance

AU - Lee, Min Ku

AU - Yang, Sung Jin

AU - Kim, Jeong Hoon

PY - 2017/1/1

Y1 - 2017/1/1

N2 - In order to handle option writer’s credit risk, a different underlying price model is required beyond the well-known Black-Scholes model. This paper adopts a recently developed model, which characterizes the 2007-2009 global financial crisis in a unique way, to determine the no-arbitrage price of European options vulnerable to writer’s default possibility. The underlying model is based on the randomization of the elasticity of variance parameter capturing the leverage or inverse leverage effect. We obtain an analytic formula explicitly for the stochastic elasticity of variance correction to the Black-Scholes price of vulnerable options and show how the correction effect is compared with the one given by the constant elasticity of variance model. The result can help to design a dynamic investment strategy reducing option writer’s credit risk more effectively.

AB - In order to handle option writer’s credit risk, a different underlying price model is required beyond the well-known Black-Scholes model. This paper adopts a recently developed model, which characterizes the 2007-2009 global financial crisis in a unique way, to determine the no-arbitrage price of European options vulnerable to writer’s default possibility. The underlying model is based on the randomization of the elasticity of variance parameter capturing the leverage or inverse leverage effect. We obtain an analytic formula explicitly for the stochastic elasticity of variance correction to the Black-Scholes price of vulnerable options and show how the correction effect is compared with the one given by the constant elasticity of variance model. The result can help to design a dynamic investment strategy reducing option writer’s credit risk more effectively.

UR - http://www.scopus.com/inward/record.url?scp=85043481983&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=85043481983&partnerID=8YFLogxK

M3 - Article

AN - SCOPUS:85043481983

VL - 51

SP - 233

EP - 247

JO - Economic Computation and Economic Cybernetics Studies and Research

JF - Economic Computation and Economic Cybernetics Studies and Research

SN - 0585-7511

IS - 1

ER -