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Valuation of Put Options on Leveraged Equity

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Abstract

This paper presents new closed form solutions for the valuation of European put options and of "down-an-in" barrier options written on leveraged equity. Unlike in past literature (Toft and Prucyk, 1997) and in keeping with empirical evidence, the model allows equity to retain value even after the firm's default and reorganisation. This stylised fact can significantly alter the valuation of equity put and "down-and-in" options as bankruptcy costs, bargaining power of equity holders, debt maturity and other firm parameters change. The value of "in-the-money" puts often decreases in the firm's assets volatility. The model can produce a variety of realistic implied equity volatility "skews".

Suggested Citation

  • Marco Realdon, "undated". "Valuation of Put Options on Leveraged Equity," Discussion Papers 03/19, Department of Economics, University of York.
  • Handle: RePEc:yor:yorken:03/19
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    References listed on IDEAS

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    6. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
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    13. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    More about this item

    Keywords

    Equity put options; Leveraged equity; Default and reorganisation; Barrier options; down-and-in options;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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