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A note on the valuation of CDS options and extension risk in a structural model with jumps

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  • Amelie Hüttner

    (Chair of Mathematical Finance, Technische Universität München, Parkring 11, 85748 Garching-Hochbrück, Germany)

  • Matthias Scherer

    (Chair of Mathematical Finance, Technische Universität München, Parkring 11, 85748 Garching-Hochbrück, Germany)

Abstract

We consider the valuation of single name CDS options (CDSO) and related optionalities, particularly extension risk, in the structural default model introduced by Chen and Kou (2009). This jump-diffusion based model is able to generate realistic dynamics for CDS spreads and has decent calibration performance. Due to the European character of the considered options, they can be valued with an efficient Monte Carlo algorithm based on Brownian bridges, adapted from Ruf and Scherer (2011). In contrast to the intensity approach, structural models offer a link to the equity side of a firm’s capital structure, possibly enabling to hedge CDS options with instruments other than CDS.

Suggested Citation

  • Amelie Hüttner & Matthias Scherer, 2016. "A note on the valuation of CDS options and extension risk in a structural model with jumps," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 3(02), pages 1-16, June.
    • Handle: RePEc:wsi:ijfexx:v:03:y:2016:i:02:n:s2424786316500110
    DOI: 10.1142/S2424786316500110
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    References listed on IDEAS

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