Novel No-Arbitrage Conditions for Options Written on Defaultable Assets

Orosi, Greg

doi:10.2139/ssrn.2459412

Cited by 2 publications

(4 citation statements)

References 14 publications

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“…The lower bounds for European call and put prices derived in Merton () (referred to hereafter as Merton's lower bounds) are based on the assumption that the underlying asset price follows a strictly positive price process, which is not the case when there is a positive probability of default. Orosi () proposes improved lower bounds under the assumption that the underlying asset can default and the price of the asset at default is zero. In the case of equity options, this means a zero equity recovery at default.…”

Section: Violation Of Lower Bounds For Options On a Defaultable Assetmentioning

confidence: 99%

“…In practice, however, Orosi's lower bounds are often violated for equity options. In this section, we first present an alternative derivation of the lower bounds proposed in Orosi (), then show that relaxing the assumption of zero equity recovery can explain the presence of violations of Orosi's bounds in practice.…”

Section: Violation Of Lower Bounds For Options On a Defaultable Assetmentioning

confidence: 99%

“…Our methodology is based on new static arbitrage-free lower bounds for European call and put option prices when the expected default probability and equity recovery are known. We derive these lower bounds by generalizing the results of Orosi (2014).…”

Section: Introductionmentioning

confidence: 98%

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Equity Option Implied Probability of Default and Equity Recovery Rate

Chang

Orosi

2016

Journal of Futures Markets

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There is a close link between prices of equity options and the default probability of a firm. We show that in the presence of positive expected equity recovery, standard methods that assume zero equity recovery at default misestimate the option‐implied default probability. We introduce a simple method to detect stocks with positive expected equity recovery by examining option prices and propose a method to extract the default probability from option prices that allows for positive equity recovery. We demonstrate possible applications of our methodology with examples that include financial institutions in the United States during the 2007–09 subprime crisis. © 2016 Wiley Periodicals, Inc. Jrl Fut Mark 37:599–613, 2017

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Section: Violation Of Lower Bounds For Options On a Defaultable Assetmentioning

confidence: 99%

Section: Violation Of Lower Bounds For Options On a Defaultable Assetmentioning

confidence: 99%

See 1 more Smart Citation

Equity Option Implied Probability of Default and Equity Recovery Rate

Chang

Orosi

2016

Journal of Futures Markets

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“…Probability of Default, Equity Recovery, and Default Barrier: MGM > Note: We calibrate the call option price formula in (17) to call options on MGM Resorts International stock in 2009. Model 1 assumes positive equity recovery and thus estimates R by …tting the observed call prices to the pricing formula.…”

mentioning

confidence: 99%