Barrier Option Pricing Using Adjusted Transition Probabilities

Barone‐Adesi, Giovanni; Fusari, Nicola; Theal, John

doi:10.2139/ssrn.964623

Cited by 5 publications

(4 citation statements)

References 11 publications

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“…Similar to the argument of Francois, et al (2011), V can be considered as the only relevant part of the country's assets which can possibly be used in debt repayment. So the actual value of national wealth should be replaced, in the spirit of the model 3 , by the nation's GDP. As a relevant value should be compared against the amount of repayment, we argue that V should be the relevant measure to monitor, and if it falls below H, then the DIP starts taking the value of a standard put as formulated in Black and Sholes (1973).…”

Section: Modelmentioning

confidence: 99%

“…K is, in the practice of option trading, the rebate offered by the writer if DIP is not knocked in before maturity, or in our context the expected repayment bonus from the creditor. Additionally, 3 Among others, Claessens and Wijnbergen (1993) use expected non-oil current account, and Karmann and Maltriz (2009) consider foreign exchange reserves to be the 'ability-to-pay' measure. It is also apparent that only a small percentage of the measure is relevant to actual repayment.…”

Section: Modelmentioning

confidence: 99%

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Forgive, or Award Your Debtor? A Barrier Option Approach

Sun

Chen

2018

JOD

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Dealing with default risk on sovereign debt became an urgent matter with the Financial Crisis of 2008. Depending on both exogenous and endogenous factors, the risk of eventual default may become significant over the lifetime of a loan. Creditors are then faced with a dilemma, since they cannot force the borrowing country into bankruptcy court. Should they ease repayment by reducing the principal of the debt (“forgiveness”), or should they offer an extra award if the borrower repays in full? The latter award could come in the form of lower borrowing costs in the future. In this article, Sun and Chen propose to model the possibility of loan modification for risky sovereign debt as a kind of down-and-in put option: There is a boundary value (the “default threshold”) for the country’s perceived ability to pay, measured as the ratio of debt principal to GDP, at which the terms of the debt are revised, either to reduce the principal or to offer a repayment award. Both approaches have been tried in practice. What the authors show is that forgiveness is better for the creditors than a repayment award. The sensitivity of bond value to default boundary, forgiveness amount, and repayment award within the model are explored through simulation. The authors then conduct an empirical analysis on the bonds of 17 of the G20 countries to estimate the values of these three model parameters, and show that their model performs well in practice.

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Section: Modelmentioning

confidence: 99%

Section: Modelmentioning

confidence: 99%

Forgive, or Award Your Debtor? A Barrier Option Approach

Sun

Chen

2018

JOD

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“…By comparing different types of barrier options, the pricing formulas of exponential barrier options were obtained when they were linked together. Barone-Adesi et al [2] according to different types of barrier options, the probability adjustment model is used to find out how to use the least effort to calculate the exact approximation of the option price.…”

Section: Introductionmentioning

confidence: 99%

Mapping of Barrier Option Pricing: A Co-citation Analysis

Zhou¹

2019

JFA

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Barrier options refer to the options that are limited in the process of their entry into force. Its purpose is to control the investors' gains or losses within a certain range. Barrier options are a special form of options. Their emergence provides a more effective way for risk managers. In recent years, barrier options have developed rapidly in the financial market. Compared with ordinary options, their trading methods are more flexible, their returns are in line with investors' wishes, and their trading prices are cheaper. They are popular with investors. Therefore, how to price barrier options has become an important research hotspot in the financial field. There is a very obvious phenomenon that the publications about barrier option pricing increasing year by year. Based on the literature data retrieved from Web of Science, this paper adopts the scientometrics analysis method to make a literature review on the pricing of barrier options, an analysis of current research situation, a co-citation analysis of literature, new trends and developments in the research field, and an analysis of sudden detection in the research field. It is concluded that "Business Finance" is the most popular subject in the field of barrier option pricing, and "Quantitative Finance" is the most frequently published journal. Among many countries in the world, USA has the largest number of publications in this field. In the field of barrier option pricing, "China University of Hong Kong" has the largest number of publications, and "general valuation framework", "flexible binomial option pricing model", "model uncertainty", "evy processes", "early exercise boundary", "model" are the main research fields of barrier option pricing. Math Finance and Merton RC are the most influential journals and authors in the field of barrier option pricing. On the whole, the research method in this paper provided a fresh research approach to assess the performance of barrier option pricing research. The findings may help for the new researchers to pick out the most relevant articles, journals, institutions and seize the research frontier in barrier option pricing field.

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“…With the addition of d, which is independent of V, the full representation of this modified form can be rewritten from (1) as (3) where Baldi, Caramellino, and Iovino (1999) and Barone-Adesi, Fusari, and Theal (2008) have discussed barrier option pricing with a binomial approximation. The approximated price of a DIC option is positively related to the exit probability,…”

Section: Introductionmentioning

confidence: 99%

Are credit spreads too low or too high? A hybrid barrier option approach for financial distress

Sun¹

2009

Journal of Futures Markets

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in this study a hybrid barrier option model to explain observed credit spreads. It is free of problems with the structural model, which underprescribed credit spreads for investment grade corporate bonds and overprescribed the high-yield issues. Unlike the standard barrier option approach, our hybrid model does not imply, for high-yield issues with firms under financial stress, a reduction of credit spreads while firm value actually falls. Our empirical analysis supports that when credit spreads are quoted abnormally higher or rising faster than expected, unexpected changes tend to persist. Otherwise a significant and prompt reversion to long-term equilibrium takes place. This asymmetric pricing phenomenon is validated with a method introduced by . The pricing asymmetry could not have been produced by a structural model employing only standard option. But it is consistent with a hybrid barrier option model. Our model characterizes the valuation of debt under financial stress and the asymmetric price pattern better than both the classical structural and the standard barrier option 1162 Lin and Sun Journal of Futures Markets DOI: 10.1002/futapproaches. It can be extended to the study of individual CDS for its better liquidity than individual corporate bonds. This study provides helpful implications especially for the medium and high-yield issues in pricing as well as portfolio diversification. 1 Geske and Delianedis (2003) has indicated that recovery rate, taxes, asset value jumps, liquidity and market risk factors could have contributed to the rest of corporate credit spreads. to credit risks. The inability of structural models to capture the nonlinearity embedded in a barrier option can be further supported by our empirical evidences. When credit spreads are quoted abnormally higher than expected, they tend to persist. Otherwise the reversion to long-term equilibrium is significant and prompt. The pricing asymmetry could not have been produced by a structural model employing only a standard option, or by a standard barrier option model. Our hybrid barrier option model proves to be an appropriate one to generate reasonable behavior of credit spreads both statically and dynamically. It characterizes the valuation of debt under financial stress and the asymmetric price pattern better than both the classical structural models and the standard barrier option approaches.Classical structural approach assumes no default prior to maturity and hence overlooks the related pricing behavior for a debt claim with imminent default before expiration. Extensions by Longstaff and Schwartz (1995) and Collin-Dufresne and Goldstein (2001) allowed preexpiration defaults but were found to only explain 15 to 25% of the observed credit spreads according to Huang and Huang (2003) and Collin-Dufresne, Goldstein and Martin (2001). Considering risky debt as including a down-and-in call (DIC) option, Giesecke (2004) showed that if the empirical value of a bond reflects that of a portfolio composed of a risk-free loan, a short European put ...

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Barrier Option Pricing Using Adjusted Transition Probabilities

Cited by 5 publications

References 11 publications

Forgive, or Award Your Debtor? A Barrier Option Approach

Forgive, or Award Your Debtor? A Barrier Option Approach

Mapping of Barrier Option Pricing: A Co-citation Analysis

Are credit spreads too low or too high? A hybrid barrier option approach for financial distress

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