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Debt rollover-induced local volatility model

Author

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  • Oleg Sokolinskiy

    (Rutgers Business School - Newark and New Brunswick)

Abstract

This paper introduces a structural scenario-based model with debt rollover risk and a higher-fidelity treatment of the bankruptcy procedure. The emerging stock price process is a generalized Brownian motion with state-dependent local volatility, and the resultant implied volatility smile is due exclusively to structural features (debt rollover and credit risks). Therefore, the model reinforces structural foundations of local volatility option pricing models. The paper advocates a joint modeling and calibration framework for multiple classes of derivatives on the firm’s asset value. In particular, an empirical application to Solar City equity and stock option valuation demonstrates the versatility and efficiency gains of the suggested model.

Suggested Citation

  • Oleg Sokolinskiy, 2019. "Debt rollover-induced local volatility model," Review of Quantitative Finance and Accounting, Springer, vol. 52(4), pages 1065-1084, May.
    • Handle: RePEc:kap:rqfnac:v:52:y:2019:i:4:d:10.1007_s11156-018-0736-3
    DOI: 10.1007/s11156-018-0736-3
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    References listed on IDEAS

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    Cited by:

    1. Bougias, Alexandros & Episcopos, Athanasios & Leledakis, George N., 2022. "The role of asset payouts in the estimation of default barriers," International Review of Financial Analysis, Elsevier, vol. 81(C).

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    More about this item

    Keywords

    Option pricing; Rollover risk; Credit risk; Local volatility; Volatility smile; Reorganization;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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