Vulnerable Derivatives and Good Deal Bounds

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Vulnerable Derivatives and Good Deal Bounds

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Titel: Vulnerable Derivatives and Good Deal Bounds
A Structural Model
Forfatter: Murgoci, Agatha
Resume: We price vulnerable derivatives - i.e. derivatives where the counter- party may default. These are basically the derivatives traded on the OTC markets. Default is modeled in a structural framework. The technique employed for pricing is Good Deal Bounds. The method imposes a new restriction in the arbitrage free model by setting upper bounds on the Sharpe ratios of the assets. The potential prices which are eliminated represent unreasonably good deals. The constraint on the Sharpe ratio translates into a constraint on the stochastic discount factor. Thus, tight pricing bounds can be obtained. We provide a link between the objec- tive probability measure and the range of potential risk neutral measures which has an intuitive economic meaning. We also provide tight pricing bounds for European calls and show how to extend the call formula to pricing other nancial products in a consistent way. Finally, we numeri- cally analyze the behavior of the good deal pricing bounds.
URI: http://hdl.handle.net/10398/8899
Dato: 2014-03-21
Note: Post print of Applied Mathematical Finance, Volume 20, Issue 3, 2013, 246-263

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