Incorporating default risk into the Black-Scholes model using stochastic barrier option pricing theory

The valuation of many types of financial contracts and contingent claim agreements is complicated by the possibility that one party will default on their contractual obligations. This dissertation develops a general model that prices Black-Scholes options subject to intertemporal default risk using stochastic barrier option pricing theory. The explicit closed-form solution is obtained by generalizing the reflection principle to k-space to determine the appropriate transition density function. The European analytical valuation formula has a straightforward economic interpretation and preserves much of the intuitive appeal of the traditional Black-Scholes model. The hedging properties of this model are compared and contrasted with the default-free model. The model is extended to include partial recoveries. In one situation, the option holder is assumed to recover α (a constant) percent of the value of the writer’s assets at the time of default. This version of the partial recovery option leads to an analytical valuation formula for a first passage option - an option with a random payoff at a random time.

Name thesis:degree_name

Ph. D.

Level thesis:degree_level

doctoral

Discipline thesis:degree_discipline

Finance

Department dc:contributor.department

Finance

Grantor dc:publisher

Virginia Tech

Year dc:date.issued

1993

Author dc:creator

• Rich, Don R.

Chair dc:contributor.committeechair

• Chance, Don M.

Committee members dc:contributor.committeemember

• Morgan, George E.
• Zia, Royce K. P.
• Reynolds, Marion R. Jr.
• Denis, David J.
• Kadlec, Gregory B.

Statement dc:rights

• In Copyright

Licence dc:rights.uri

• http://rightsstatements.org/vocab/InC/1.0/

Language dc:language.iso

en

Dc Identifier Other

etd-06062008-171359

OAI identifier oai:identifier

oai:vtechworks.lib.vt.edu:10919/38470