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Pricing of vulnerable options under hybrid stochastic and local volatility

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  • Kim, Donghyun
  • Choi, Sun-Yong
  • Yoon, Ji-Hun

Abstract

In this study, considering the paradoxical stochastic characteristics of over-the-counter markets during a financial crisis, we examine the price of vulnerable options under the constant-elasticity-of-variance-with-stochastic-volatility (SVCEV) model. This model describes the market situation better than the stochastic volatility model as well as the constant-elasticity-of-variance model. We provide the corrected option price derived by asymptotic analysis, which is an approximation to the price of a vulnerable option under the SVCEV model. Furthermore, we numerically verify the accuracy of the price of a vulnerable option (as obtained using the SVCEV model) by comparing the approximate option price with the option price obtained by Monte Carlo simulation.

Suggested Citation

  • Kim, Donghyun & Choi, Sun-Yong & Yoon, Ji-Hun, 2021. "Pricing of vulnerable options under hybrid stochastic and local volatility," Chaos, Solitons & Fractals, Elsevier, vol. 146(C).
    • Handle: RePEc:eee:chsofr:v:146:y:2021:i:c:s0960077921001995
    DOI: 10.1016/j.chaos.2021.110846
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    Cited by:

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    2. Kim, Donghyun & Kim, Geonwoo & Yoon, Ji-Hun, 2022. "Pricing of vulnerable exchange options with early counterparty credit risk," The North American Journal of Economics and Finance, Elsevier, vol. 59(C).
    3. Ha, Mijin & Kim, Donghyun & Yoon, Ji-Hun, 2024. "Valuing of timer path-dependent options," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 215(C), pages 208-227.
    4. Donghyun Kim & Ji-Hun Yoon, 2023. "Analytic Method for Pricing Vulnerable External Barrier Options," Computational Economics, Springer;Society for Computational Economics, vol. 61(4), pages 1561-1591, April.
    5. Xie, Yurong & Deng, Guohe, 2022. "Vulnerable European option pricing in a Markov regime-switching Heston model with stochastic interest rate," Chaos, Solitons & Fractals, Elsevier, vol. 156(C).

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