Pricing of Defaultable Securities under Stochastic Interest
AbstractWe reduce the problem of pricing continuously monitored defaultable securities (namely, barrier type options, corporate debts) under a stochastic interest rate framework to calculations of boundary crossing probabilities (BCP) for Brownian Motion (BM) with stochastic boundaries. For the case when the interest rate is governed by linear stochastic equation (Vasicek model) we suggest a numerical algorithm for calculation of BCP based on a piece-wise linear approximation for the stochastic boundaries. We also provide an estimation for a rate of convergence of the suggested approximation as a function of number of nodes and illustrate the results by numerical examples.
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Bibliographic InfoPaper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 193.
Date of creation: 01 Feb 2007
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-03-03 (All new papers)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Merton, Robert C, 1974.
"On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,"
Journal of Finance,
American Finance Association, vol. 29(2), pages 449-70, May.
- Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- G. O. Roberts & C. F. Shortland, 1997. "Pricing Barrier Options with Time-Dependent Coefficients," Mathematical Finance, Wiley Blackwell, vol. 7(1), pages 83-93.
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