Closed-Form Interpolation-Based Formulas for European Call Options Written on Defaultable Assets

Journal of Asset Management, Vol. 16, No. 4, 2015.

13 Pages Posted: 26 Dec 2014 Last revised: 24 Oct 2015

Date Written: February 20, 2015

Abstract

In this paper, we derive closed-form, interpolation-based expressions for European call options written on defaultable assets. Our results are based on the work of Henderson at al. (2007), who derive formulas that incorporate standard static no-arbitrage restrictions, and Orosi (2014) who establishes an improved lower bound for European call options written on defaultable assets. Although, in general, the models are incapable of representing the entire call option surface because of the low number of parameters, we demonstrate their applicability to extract important quantities from quoted options. In particular, the probability of default, the size of a default barrier, and the recovery rate can be inferred from the model.

Keywords: call option pricing; European call option; closed-form formula; default; probability of default

JEL Classification: C58, G13

Suggested Citation

Orosi, Gergely (Greg), Closed-Form Interpolation-Based Formulas for European Call Options Written on Defaultable Assets (February 20, 2015). Journal of Asset Management, Vol. 16, No. 4, 2015., Available at SSRN: https://ssrn.com/abstract=2542634

Gergely (Greg) Orosi (Contact Author)

affiliation not provided to SSRN

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