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A Note on Contingent Claims Pricing with Non-Traded Assets

  • Ericsson, Jan

    ()

    (McGill University)

  • Reneby, Joel

    ()

    (Dept. of Finance, Stockholm School of Economics)

One of the main objections to applying contingent claims analysis outside the area of derivatives pricing, such as to the pricing of corporate (or sovereign) debt, has been that it is not possible to trade in the relevant state variable, e.g. the assets of a firm. Consequently, replicating portfolios can not be formed and preference free pricing does not result. The aim of this paper is to show that assuming traded assets, as is routinely done, is inconsistent with the presence of stocks and bonds. It is also unnecessary. We argue that a superior alternative to obtain a complete markets setting, is to assume that at least one of the firm's securities, e.g. equity, is traded.

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File URL: http://swopec.hhs.se/hastef/papers/hastef0314.pdf
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Paper provided by Stockholm School of Economics in its series SSE/EFI Working Paper Series in Economics and Finance with number 314.

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Length: 8 pages
Date of creation: 29 Mar 1999
Date of revision: 01 Feb 2002
Handle: RePEc:hhs:hastef:0314
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  1. 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.
  2. Hayne E. Leland and Klaus Bjerre Toft., 1995. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Research Program in Finance Working Papers RPF-259, University of California at Berkeley.
  3. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
  4. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
  5. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
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